One scenario we frequently see is when someone is ready to move but hesitant to sell their current home. Instead, they consider converting the property into a rental. This often comes up when someone buys their first home or condo, then later starts a family and needs more space.
While the emotional side of the decision can be challenging, there are two major financial considerations to make.
1. Will the Rental Make Financial Sense?
This is the most obvious factor, and the answer can be complex. You’ll want to evaluate rental income potential, expenses, taxes, and long-term appreciation. (We’ll cover that in another post.)
2. What Happens to the Capital Gains Tax Exclusion?
A lesser-known but critical issue is whether you’ll still qualify for the capital gains tax exclusion if you turn your primary residence into a rental.
Under current IRS rules, homeowners can exclude up to $250,000 of capital gains (or $500,000 if married filing jointly) on the sale of a primary residence — as long as they’ve lived in the home for two out of the past five years.
Here’s an example:
Let’s say you bought a condo years ago for $250,000, and today it’s worth $500,000. If you sell it now, you could exclude the entire $250,000 gain and avoid paying capital gains tax.
But if you decide to move into a new home and rent out the condo instead, the clock starts ticking. After three years of renting it out (and not living there), you’ll no longer meet the “2 out of 5 years” rule — and you’d likely owe tax on that $250,000 gain if you sell.
Other Considerations
There may be good reasons to keep the home as a rental, even if it means losing the exclusion:
- You need the home sale proceeds for a down payment on your next home.
- You expect strong rental income and long-term appreciation.
- You plan to hold the property until death to benefit from a step-up in basis.
- You intend to use a 1031 exchange to defer taxes.
These are all valid strategies, but the decision to convert your home into a rental involves careful tax and financial planning.
If you’re considering this move and want help evaluating your options, we’re here to help. Schedule a call with our team using the link below to receive personalized guidance.
Bautis Financial LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.