Turn an investment property into your home
Tips to transitioning your investment property
- Stop renting the property, but follow local eviction laws.
- The IRS allows you to exclude sale proceeds if you lived in the house for two years.
- You won’t be able to continue deducting expenses from the property.
Converting an investment property into your primary residence sounds easy — and it is, on the surface: You stop renting out the property, move in, and live there.
But converting an investment property into your primary residence brings up a whole host of regulatory and tax issues that must be addressed.
Obviously, to convert a rental property into your personal residence, the first step is to stop renting the property out. To qualify as a residential property, you must live in it for more than two weeks out of the year, or for more than 10 percent of the days it would be available to rent out. If you are currently renting the property, don’t kick the tenants out immediately; follow the terms of the lease and local laws dictating when and how you can evict tenants.
When converting an investment property into your personal residence, understand the tax implications that come with such a conversion.
Internal Revenue Code 121 allows you to exclude as much as $500,000 in proceeds from selling your property if you’re married, or $250,000 if you’re single, if the taxpayer has owned and lived in the residence for two of the previous five years. If you’re married, then both spouses must meet the two-year residency requirement. You must not have used the exclusion when selling a home in the past two years.
You can live in the house for any time totaling two years within the five-year timeframe. You don't have to live in the house when you sell it.
On the other hand, by converting the property into a personal residence, you no longer will be allowed to deduct expenses from the property on your taxes.
Exceptions to the rules
There are exceptions to IRC 121. If you used the property as a rental, vacation home or other “non-qualifying use,” you can’t exclude the portion of gain resulting from the non-qualified use from your gross income. This is a result of a special rule enacted by Congress in 2009.
If you convert a property that you initially used as your primary residence into an investment property, however, the limit does not apply. If the investment activity takes place after your use of the property as a primary residence, you can exclude the full $500,000 or $250,000 from your taxes.
There are some circumstances in which you can reside in the house for less than two years. These include:
- Residing in the home for any period after the last day the home was used as the principal residence until the date of sale, as long as it’s five years before the date of the sale;
- Any period, no longer than 10 years, in which you served on qualified official extended duty; and
- Any other period of temporary absence, no longer than two years, because of health conditions, changes of employment or other unforeseen circumstances.
Converting an investment property to a primary residence while minimizing your tax burden is relatively easy. Just follow local laws when evicting tenants as you move into the property. And if or when you decide to sell the property, follow the guidelines stated in IRC 121, and speak to your tax and legal advisors.