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  • Real estate as 529

    I purchased my first home for 300k in 2010. It is now worth 400k and I still need to pay 190k on it at 2.62%/15y. When I got my current home in 2014, I rented out the first one. I need to put about 4k/year on top of rent to cover the mortgage, income taxes and maintenance, so I am rather happy about that.

     

    My original plan was to keep the first home and sell it in 2030, when my first kid goes to college and use the 700k estimated selling price for college (I have more than one kid, no 529 yet). The problem I see is that if I sell in 2030 for 700k, I will pay taxes on 700-300=400k (I know it is more complicate and I can deduct the cost of the sale and of the purchase, but I am simplifying here). I am not sure if I will pay 16% capital gains taxes or regular income taxes on the 400k. Assuming regular income taxes, then this will eat half of my profits (39.6 marginal + 8.5 state).

     

    I am curious if I can move back (without wife and kids) in 2027, stay in the basement till 2029, rent the rest of the house, and sell in 2030 and claim it was my primary residence for 2 of the past 5 year prior to the sale. What happens if it is your primary residence, but you also rent part of it (maybe a room to a student, maybe more, maybe you AirBnB it)?

     

    Advice appreciated.

  • #2
    I wrote a post about this a while back.

    https://www.whitecoatinvestor.com/real-estate-as-a-college-savings-tool/

    First, you'll only have to pay taxes on $700K-$400K, you get to use the basis when you put it into service as a rental.

    Second, you pay it at a capital gains rate, but you pay a higher rate on depreciation recapture.

    If you're really willing to go through that much trouble to move back in, I agree you can probably avoid those taxes.
    Helping those who wear the white coat get a fair shake on Wall Street since 2011

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    • #3
      Thank you for the post. I have found more details here https://www.kitces.com/blog/limits-to-converting-rental-property-into-a-primary-residence-to-plan-for-irc-section-121-capital-gains-exclusion/ It is much much more complicated that I have initially thought. For example, if the house is partially rented out, you must "prorate". Also, if you live in the house for 2 years, move out for 13, then come back for another 2, you must exclude the appreciation during the 13 (or maybe 13-3, where 3 is the initial 5-2=3). Becomes very messy. What is worth doing is keeping records of every expense on the rental, since all that can be deducted. Otherwise, 529 seems much simpler. Must do some math to figure out if the rental actually make financial sense.

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      • #4




        I purchased my first home for 300k in 2010. It is now worth 400k and I still need to pay 190k on it at 2.62%/15y. When I got my current home in 2014, I rented out the first one. I need to put about 4k/year on top of rent to cover the mortgage, income taxes and maintenance, so I am rather happy about that.

         

        My original plan was to keep the first home and sell it in 2030, when my first kid goes to college and use the 700k estimated selling price for college (I have more than one kid, no 529 yet). The problem I see is that if I sell in 2030 for 700k, I will pay taxes on 700-300=400k (I know it is more complicate and I can deduct the cost of the sale and of the purchase, but I am simplifying here). I am not sure if I will pay 16% capital gains taxes or regular income taxes on the 400k. Assuming regular income taxes, then this will eat half of my profits (39.6 marginal + 8.5 state).

         

        I am curious if I can move back (without wife and kids) in 2027, stay in the basement till 2029, rent the rest of the house, and sell in 2030 and claim it was my primary residence for 2 of the past 5 year prior to the sale. What happens if it is your primary residence, but you also rent part of it (maybe a room to a student, maybe more, maybe you AirBnB it)?

         

        Advice appreciated.
        Click to expand...


        Presuming that the capital gains tax rates will remain the same for the next 14 years (anybody want to wage on that?), you will pay capital gains taxes at 25% on any depreciation recapture then at 20% on the balance of gain. By then, you will have depreciated 20 out of 27.5 years, so there will be that much to recapture. This doesn't go away even if you live there 2 of 5 years. You are still 14.9% ahead, though, if your marginal rate remains 39.6%.

        As you mentioned, you'll get to increase your basis (reduce the gain) by improvements to the property and your selling expenses will also reduce the gain.

        If you move back for 2 years, you would be able to exclude $250k of gain since it would be you only, not your spouse.
        Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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