In our previous blog post, we covered taxes on selling primary residences. Converting the use of a property can change your tax liability when it comes time to sell. Knowing the laws will help you maximize your investment and save significant money. This overview on taxes on selling primary residences converted to investment properties is something that you should keep in mind.

Calculating Gains for an Investment Property

Calculating gain on a single family home is slightly different from that of an investment property. The overall formula is the same, but how the adjusted basis is calculated is different.

Net Sale Price – Adjusted Basis = Gain

Net Sale Price – This is the sale price minus expenses such as closing costs and brokerage fees (but excluding property taxes and utility adjustments).

Adjusted Basis – This is the purchase price plus closing costs (title insurance, brokerage fees, lending fees) and capital improvements. However, you must subtract any depreciation taken on previous tax returns.

Qualifying for the Capital Gains Exclusion

There is a capital gains exclusion on homes used for primary residences. The amount is $250,000 for single filers or $500,000 for married filers. You qualify if you lived in the home for 2 out of the last 5 years of the date preceding the sale. You can use the exclusion if you sell within a certain time frame or re-establish primary residency to meet the criteria.

Here are a few examples. For ease of calculation, we’re going to assume full calendar years in the following examples.

Example 1 – You lived in a home for 3 years and then rented it out for 3 years. Thus, you used the home as a primary residence for 2 out of the last 5 years. You qualify for the exclusion.

Example 2 – You lived in a home for 3 years and then rented it for 4 years. Unfortunately, within the most recent 5 years, you only lived there for 1. You cannot use the exclusion.

Example 3 – You lived in a home for 2 years, rented it for 3 years, and then lived in it again for 1 year. Over the last 5 years, you still lived in it for 2 years. The primary residence timeframe does not need to be sequential. You still qualify for the exclusion.

Capital Gains Taxes

Avoiding capital gains taxes on selling primary residences converted to investment properties can save you significant money. Let’s assume a low end capital gain tax rate of $15% for federal and 5% for Massachusetts. On a gain of $100,000, that saves you over $20,000 in taxes!

Other Taxes on Selling Primary Residences Converted to Investment Properties

There are many other tax considerations and savings opportunities when it comes to single family residences converted to investment properties. The examples above are simplified for illustration purposes only. Calculations on your properties may be more complex given the particular property and your past and current finances. Consult with your tax preparer or accountant for accurate estimates for your properties and other ways you might be able to save money on a sale.

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