Introduction
If you’ve bought a new home and are still trying to find a buyer for your old home, you may decide to rent your old home to others temporarily. Fortunately, even if you rent your home to others temporarily, it may still qualify as your principal residence for federal income tax purposes (if you meet all of the requirements). That means that you may be eligible to exclude all or part of the capital gain that may arise when you sell the home. On the downside, though, you won’t be able to deduct a loss on the sale. Along with capital gain or loss treatment, you should understand any other issues that may impact your federal income tax return when you rent your principal residence temporarily.
What constitutes a temporary rental, as opposed to a permanent conversion to rental property?
To determine whether or not rental is temporary and should therefore follow the principal residence tax rules, courts generally look to the intent of the taxpayer. Evidence that the home continues to be listed for sale during the rental period, that the lease is short-term, or that a depressed real estate market has made a sale difficult all tend to indicate principal residence status. Unlike a permanent conversion of a principal residence to rental property, your property may still be considered your principal residence even if you list it with a real estate agent for sale or lease.
Under what conditions can you exclude gain from the sale of your home?
The homesale exclusion applies only to the sale of your principal residence. The home in which you spend most of your time during the year will ordinarily be considered your principal residence. (However, the IRS has listed other factors that are relevant in determining your principal residence.)
If you sell your principal residence at a gain, you may be able to exclude from federal income taxation all or part of the capital gain. If you meet the requirements, you can exempt up to $250,000 (up to $500,000 for married couples filing jointly) of the capital gain, regardless of your age.
You can generally exclude the gain only if you owned and used the home as your principal residence for at least two out of the five years preceding the sale (the two years do not have to be consecutive). An individual, or either spouse in a married couple, can generally use this exemption only once every two years. Even if you fail to meet these tests, though, you may be eligible for a partial exclusion of capital gain.
What are the other federal income tax consequences of a temporary rental?
From a tax perspective, you can offset rental income with allowable interest and property tax deductions if you temporarily rent a personal residence. To the extent that the rental income exceeds these otherwise allowable deductions, you can also claim rental deductions for maintenance, insurance, and depreciation. However, the expenses are limited to the amount of rental income. You cannot claim an overall loss from rental activities if you rent your residence temporarily.
For more information, see IRS Publication 527, Residential Rental Property.
Where do you report the rental income?
Typically, the rental income from activities not engaged in for profit (e.g., temporary rental income) should be reported on the “Other Income” line on page 1 of Form 1040. The expenses allocable to this income (other than qualified residential interest and taxes) are deductible as miscellaneous itemized deductions to the extent that they exceed the 2 percent of adjusted gross income (AGI) threshold.
Conclusion
Temporarily renting your principal residence may offer flexibility while you search for a buyer, and it can still provide favorable tax treatment if handled correctly. If your intent to sell remains clear and your use of the home aligns with IRS guidelines, you may preserve the opportunity to exclude capital gains upon sale. However, it is important to be mindful of the limitations on rental loss deductions and reporting requirements. Keeping detailed records, clearly documenting your intent to sell, and consulting a tax advisor can help ensure that you receive the full benefits available under the current tax rules.
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Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
