On January 1, 2011, she evicts her tenants and moves into the house, thereby converting it to her principal residence. The first residence can then be converted to a rental property. Example: Jane buys a home on January 1, 2009 for $400,000, and uses it as rental property for two years. For example, the property sold is a farm, and the farmhouse meets both the ownership test and the use test, but the barn does not meet the use test. Turning Your Rental Property Into A Primary Residence You Can Also Convert A Rental Property To A Primary Residence – Using A 1031 Exchange. Turn your primary residence into a rental. When you sell an investment property, you will be subject to a capital gains tax. She then sells the property for $700,000 on January 1, 2014. If your home has appreciated in value since you bought it, you can get both some tax-free income using the $250,000/$500,000 exclusion and a step-up in your depreciation basis by selling your home to your S corporation. Another way to manage a 1031 exchange on a personal residence is to do the reverse of the previously explained situation. If you sell a depreciable property through a 1031 exchange, special depreciation recapture rules can apply. Now you can do a 1031 exchange and defer all of the capital gains from a sale of that property. The two years don't have to be consecutive. If you sell your stocks or bond and buy a property residence, the IRS will not let you do a 1031 exchange (a properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes). You will have to report the Capital gain - to qualify for a residential deduction you have to reside in your home for 2 years out of the last 5. Provided they lived in the home as their primary residence for at least two years, they could sell it and exclude the gain under Section 121 up to the maximum level of $250,000/$500,000. If you convert your rental home into your primary residence, you can avoid capital gains taxes, but it’s not a quick fix. In recent years Congress amended Section 121 in order to limit the benefits of Section 121 when the property has also been used as a rental. For more information, check out our in-depth guide to 1031 exchange rules in real estate. (This is the new S corporation you will create when you finish reading this article.) When selling your converted rental property, you lose the home sale exclusion. All right, so you’ve established that your property is no longer your primary residence, but a rental property. On your primary residence, the gain is exempt up to $250,000 for a single owner and $500,000 for married couples. On January 1, 2013, she moves out and rents it again. Turn the investment property into your primary residence. You can’t live in your house at all while it’s a rental property, and you must actually rent it out for some period of time. 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