Can taxes be deferred when selling a rental property?

Can taxes be deferred when selling a rental property?
Date Published: April 4, 2014

Dear Sue,
My wife and I bought a rental home in Auburn eight years ago.
We were living in Colorado at the time. Our good tenant of four years moved out. It needed a little work and we wanted to get back to California so we moved into it for three years. We re-rented it last year and returned to Colorado.
We want to sell it and reinvest the $100,000 or so that we’ve made on it. We decided to stay in Colorado permanently and want to buy a new home for ourselves.
We are concerned about the tax impact of the sale. It may not leave us with enough to buy what we want. Is there a way around it?
~Taxed Tom
Dear Tom,
First, you must seek the advice of a trusted tax professional.
It sounds to me as if you are treating the potential sale as an investment property.
According to the tax code you do not need to occupy a property as a principal residence when the property is purchased or at the time of the sale to qualify for up to $500,000 profit exclusion.
You can qualify for this exclusion if you have occupied the property for two out of the last five years.
Based on the information that you have given me there should be no tax impact on your sale.
You acquired the property as a rental eight years ago.
Four years later you occupy the property as your principal residence. You live in the property for three years before moving out. You move out and a year later you decide to sell.
Under the current tax code married couples are allowed a $500,000 tax-free profit if they have occupied the property they are selling for two out of the last five years.
If you had never moved in to your rental property and decided to sell, you could defer the tax impact on the profit by doing a 1031 tax deferred exchange. The value of the investment property that you exchange into must be of equal or greater value than the relinquished investment property in order to defer all of the taxation.
Some people exchange into investment properties that they later convert to their personal residence. I strongly advise you to discuss this strategy with your accountant. Understanding the tax code will be a matter of good Home $$$s and Sense.
Sue Thompson is the owner of HomeTown Realtors in Auburn. She can be reached at seesue@mac.com, or at www.homedollarsandsense.com.