Can we claim $500K tax break if renting to tenants?

Couple learns tax implications of selling primary home, rental

By Robert J. Bruss
Inman News

DEAR BOB: We have rented out a legal apartment in our primary residence for 17 years. My wife and I intend to sell our house and shelter $500,000 of our gain. In order to do so, must we be "tenant free" for 24 of the last 60 months? --Bruce C.

DEAR BRUCE: No. You can sell your principal residence with the tenant still living in the apartment.

For capital gains tax purposes you will be making two sales. One is the sale price of your principal-residence portion. The other sale is the sales price of the rental apartment.

But the Internal Revenue Code 121 principal-residence-sale tax exemption up to $500,000 for a qualified married couple (up to $250,000 for a single home seller) applies only to your capital gain profit on the principal-residence portion. That's presuming you both occupied your primary residence at least 24 of the last 60 months before the sale.

The capital gain on the sale of the rental apartment has two components. One is the "recapture" tax at the special federal tax rate of 25 percent for the depreciation you deducted after May 6, 1997. The other part of the capital gain on the rental apartment is taxed at a maximum federal tax rate of 15 percent. For full details, please consult your tax adviser.

EVICT TENANTS IF YOU FEEL STRONGLY ABOUT THEIR BREACH OF LEASE

DEAR BOB: What recourse do I have when my rental tenants don't honor the terms of their lease? The house they rent from me has a nice yard. The lease terms require them to maintain the property. But the trees look like they are dying. I asked my tenants to water the trees, but they say they don't have time. What are my options to have them honor their agreement to maintain the property? --Lisa D.

DEAR LISA: Even if your tenants have a lease, if it requires them to maintain the yard and they fail to do so, you can evict them if you feel strongly about their breach of the lease terms.

Just follow the state unlawful detainer (eviction) procedure, such as delivering a "Notice to Quit" and then filing the court lawsuit. If this is your first eviction, I suggest you hire a local attorney who specializes in evictions so you can learn how it is done.

If the lease is about to expire and you don't want to evict, you have another alternative. It is to substantially raise the rent (presuming no rent-control limit applies). The tenants will then either move out or you will have the extra rent money to hire a gardener to keep the yard and trees looking good.

CHECK SPOUSE'S DEBTS BEFORE ADDING HER TO HOME TITLE

DEAR BOB: I want to add my spouse (not married) to my deed. We want to take advantage of that $500,000 tax break when I sell our home. But I want to be sure she has no liens before I do this. She had several loans with her ex-husband and then a bankruptcy. She went to our local courthouse and was told there were a couple of liens but it looks like they were cleared. How can I verify this before proceeding? --Harry G.

DEAR HARRY: You say you want to add your spouse's name to your deed but you're not married. If she is not married to you, she is not your spouse.

The only way to be sure she doesn't have any liens that could attach to your home's title if you add her name is to obtain a new owner's title insurance policy. Before issuing such a policy, the title insurer will thoroughly check for possible judgments and other liens against her. Her informal search at the courthouse was a waste of time.

However, if you are legally married to her and you want to claim the Internal Revenue Code 121 principal-residence-sale tax exemption up to $500,000 (instead of $250,000 for a single home seller), her name does not have to be on the title. However, to qualify for the $500,000 exemption, you both must occupy your principal residence at least 24 of the last 60 months before its sale. For full details, please consult your tax adviser.

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