Investment Property to Personal Residence

New Limits on Gain Exclusion!

Do you plan to convert an investment property into your personal residence? The Housing Assistance Tax Act of 2008 that President Bush signed into law on July 30, 2008 carries a provision that affects the practice of excluding gain when you sell a property that was once used for another purpose, such as a rental property, and then converted into your personal residence. The effect of the new law is a restriction on the amount of gain you can exclude through Section 121, the personal residence exclusion section of our tax code.

Section 121 of the Internal Revenue Code allows a gain of up to $250,000 ($500,000 if you are married and file jointly) with no tax obligation when you sell a house used as a primary residence for two of the previous five years. You don't even need to occupy the property for two consecutive years during the five year period; just two years out of the five in any form.

As of January 1, 2009, the new law reduces the amount of gain that you can exclude if you have used the property for any purpose other than as a primary residence. The reduction is applied on a pro rata basis by determining the percentage of years the property is not used as a primary residence purposes to the total years the property is owned by the taxpayer.

Sometimes examples help clarify things. Here's one: a married couple acquires a house that they use as a rental in 2009. The couple rents the house for four years, and then moves into it and uses it as their primary residence for the next two years. The couple sells the property at the end of year 6 with a gain of $300,000. Applying the old law, the couple would be eligible for the full $500,000 exclusion and would owe no tax. The new law requires the application of the proration described in the paragraph above. Two-sixths (two out of six years) of the gain, or $100,000 would be eligible to be excluded.

Exceptions to New Law:

A couple of interesting exceptions to this new restriction exist. First, periods in which the property is not used as a primary residence that occur prior to January 1, 2009 do not reduce the excludable gain. Using the example provided above, if the three year rental period occurs prior to January 1, 2009, the exclusion would not be reduced and the couple would be able to exclude gain on the sale up to the full $500,000.

A second interesting exception is if you convert property that you first used as your primary residence into investment property, it will not be affected by this new law. By way of example, consider this scenario: you own and live in a house for eight years, at which time you move out and rent the house for two years before selling it. Since your investment use of the property took place after your use as a primary residence, all of the gain accumulated over your 10 year ownership of the property can be excluded up to the $250,000/$500,000 limits.

There are also some limited exceptions for taxpayers who serve on "qualified official extended duty" or are temporarily absent due to changes of employment, health conditions or other unforeseen circumstances. Individuals in those situations should have their tax advisors review the new law to determine whether the exceptions could be of benefit to them.

Combining Exclusion with 1031 Exchange

One thing that did not change is the requirement to own property for at least five years if you acquire it in a 1031 exchange and subsequently convert it to your primary residence before it is eligible for the Section 121 exclusion.

If you convert your primary residence to an investment property and subsequently sell the property, you should be eligible to combine your Section 121 exclusion with a Section 1031 tax deferral for the gain that is not excludable under Section 121.

Hopefully this did not make your head spin too much. It is clear that some complicated situations could arise out of the application of this new law. Advance planning through consultation with your tax advisor is a must. The inclusion of a knowledgeable exchange expert in the planning process would be equally beneficial.

Please consider our resources as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Short Sale Essentials
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A Short Sale is a carefully agreed upon sale of a property where a lender is willing to accept less than the amount owed on it because the borrower, due to an acceptable hardship, is unable to make payments.

For homeowners, there are only 23 universally “acceptable hardships” that cause “unexpected” financial crisis in their lives. The lender accepts an offer to purchase from a 3rd party buyer, thus relieving the original owner from encumbrances and potential, future liabilities. Home lenders are willing to take less for the home than is owed on it and less than it’s worth in today’s declining market. Why? Because lenders will lose more if the property goes into foreclosure, and so will the homeowner.

There are three stages in the foreclosure process. They are pre-foreclosure, foreclosure and post– home foreclosure.

The pre-foreclosure stage is the only one where everyone comes out a winner. In the foreclosure stage, the homeowner’s FICO credit score can be reduced by 250-280 points and it will take 3-5 years before a lender will offer a sensible interest rate to make it possible to buy another home.

In the “pre-foreclosure redemption status” stage, with the help of a Realtor® , trained to negotiate a "short sale" with the lender, the FICO credit score will only take an 80-100 point "hit", and the homeowner will be able to buy another home with a good rate in 18 months to 2 years or less.

Other advantages of the "short sale" option in the pre-foreclosure stage include the possibility of leasing back the home from a third party investor/buyer, no defficiency judgement, no repair costs, no money to closing, stopping nagging collectors, avoid bankruptcy, a smoother transition to get out from under and get on with life. As a trained Realtor® you will be able to explain the other pre-foreclosure options you have to assit you a distressed Seller in making a decision that's in their best interest.

With over 1 million properties expected to be in foreclosure this year, the difference in losses to be sustained by lenders between a negotiated short sale and a fully executed foreclosure is estimated to be in excess of $50 Billion. The costs to the Lender for commissions, closing costs, basic repairs, property maintenance, insurance, taxes, homeowner association dues, eviction and court costs, attorney fees, and much more averages about $400 a day for an average priced home.

Over the 11+ months that the Lender has to carry the property and their hard costs can add up to over $130,000. When you subtract these costs from the reduced sale’s price dictated by the depressed market and then take that sum away from the over-extended loan balance, the lender’s loss is substantially greater than a quick short sale. Time certainly is money!

It should come as no surprise to Sellers that they’re behind in their payments or can’t afford to continue making payments on their home because of a recent rate adjustment or for whatever other reason that has put their life in crisis. Sellers should not ignore the notice or telephone call that reminds them of their obligation. They should call their lender immediately so they won’t accelerate the process of foreclosure.

Remember, the lender does not want the property. Realtors® play the most important role in helping distressed Sellers reorganize their obligation to make their home more affordable, or get them out from under. by creating a WIN-WIN-WIN situation.

The National Bureau of Economic Research on Monday determined that a peak in economic activity occurred in the U.S. in December 2007, and declared the U.S. economy officially in recession since that time. The December 2007 peak marked the end of the expansion that began in November 2001 and lasted 73 months; the previous expansion of the 1990s lasted 120 months.

A recession, as defined by the National Bureau of Economic Research, is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion.

Because a recession is a broad contraction of the economy, not confined to one sector, the National Bureau of Economic Research emphasizes economy-wide measures of economic activity when determining a recession."It's more accurate to say that a recession -- the way we use the word -- is a period of diminishing activity rather than diminished activity," the National Bureau of Economic Research said in a prepared statement.