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Ask Millionacres -- Will I Owe Cap Gains on a Rental Investment?

[Updated: Apr 20, 2020 ] Mar 19, 2020 by Matt Frankel, CFP
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Q: We've owned an investment/rental home in Nevada since 2013 and are retired. We are currently living in this home and are now renting out our former primary home in Utah. We kept our Utah residency status -- we are registered voters in Utah, have Utah driver's licenses, and we file Utah tax returns. In June 2021 we plan to sell the Nevada house that we currently live in so we can live off the gains. In 2021 our only major source of income will be from the Utah house rent. The Nevada sale gains will be approximately $200,000. Due to our low income, will we qualify for the 0 percent capital gains tax bracket? To my knowledge, we won't qualify for the home sale gain exclusion since we are not technically Nevada residents according to IRS pub 523. Will we have to pay capital gains tax? -- Marianne

First off, Marianne, keep in mind that I am not a tax advisor and don't have an intimate knowledge of your personal situation beyond what you shared in your question. When the time comes to actually sell your Nevada home, I strongly advise you to consult a tax attorney or other qualified professional who can analyze your specific situation. It'll likely cost you a few hundred dollars, but it's worth it.

Having said that, I'm not 100% convinced that you won't qualify for the home sale gain exclusion. For readers who aren't familiar, sellers can exclude as much as $250,000 in capital gains ($500,000 for married couples filing joint returns) if the home they sell meets the IRS definition of a primary residence. According to IRS Publication 523:

"An individual has only one main home at a time. If you own and live in just one home, then that property is your main home. If you own or live in more than one home, then you must apply a 'facts and circumstances' test to determine which property is your main home."

And you're absolutely correct that the IRS cites things like having the home's address on your driver's license and voter registration when proving that it's your main home.

Now, you obviously own more than one home. However, you don't split your time between the two, if I understand your situation correctly. In other words, the Nevada home is where you live 100% of the time right now, and the Utah home is available to your tenants 100% of the time. In Publication 523, the IRS goes on to say (immediately following the text quoted earlier) that the "most important factor is where you spend the most time."

Since you spend all of the time in the Nevada home, it could potentially still meet the definition of a primary home, as long as you've used it as such for at least two of the five years before you sell it. In short, if you own two homes but exclusively live in one of them, that one is likely your main home.

Plus, while your driver's license and voter registration is from a different state, there can be other ways to show the IRS that it is indeed your main home. For example, if you live there exclusively, you probably receive mail there. Showing that you receive all of your mail there (your postal address is in Nevada) is one of the tests the IRS mentions. You could also include a copy of the lease that the tenants in your other home signed in order to document that you don't use it for personal reasons at all.

As a final thought, the most important concept (by far) when it comes to the capital gains tax exclusion is that you can only have one main home at a time. And since your other home is rented out on a year-round basis, there's little room for dispute that the home you're living in is your main home.

And just to reiterate, this is just my opinion of your situation, and I'm not intending this to be personalized financial advice. Check with a tax professional before attempting to exclude your gains from taxation. And best of luck with the sale!

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