Converting an investment property to a primary residence can provide substantial tax benefits for homeowners. By changing the use of a property from an income-generating rental to a primary home, homeowners can qualify for capital gains tax exclusion upon selling the property. Additionally, property taxes, mortgage interest, and other expenses become deductible. However, there are costs associated with converting investment property to primary residence. Following proper procedures is essential to realize the full tax benefits. This guide provides a step-by-step overview of the conversion process.
Determine If Conversion Makes Sense Financially
The first step is evaluating if converting the investment property to a primary residence makes good financial sense. Homeowners should calculate costs like realtor commissions and capital gains taxes if the property were sold as a rental. These can be compared to savings from capital gains exclusion and income tax deductions when used as a primary residence. Consulting a tax professional can help analyze the numbers to see which option is more advantageous.
Review Lease Terms and Plan Timing
If the investment property is currently rented out, review the lease terms to see when it can be terminated or when the lease ends. Provide tenants sufficient notice as required by law that their lease will not be renewed. Time the conversion so vacant possession aligns with moving into the home as a primary residence. Planning the transition between tenants leaving and the owner moving in is critical.
Comply With Residency Requirements
To qualify for capital gains exclusion when selling, owners must have resided in the home as their primary residence for at least 2 out of the last 5 years prior to sale. To ensure this residency requirement is met, move into the converted home as soon as possible after tenants vacate. Establish proof of residency by transferring utilities to your name, changing your mailing address, registering to vote using that address, and obtaining a homestead exemption.
Report Property Status Changes
File paperwork to report the change in use of the property from an investment to a primary residence. Submit an updated IRS form Schedule E reflecting the property is no longer being used as a rental. Notify the lender if refinancing the mortgage. Contact the county tax assessor’s office to update the homestead exemption status.
Converting an investment property to a primary residence can provide substantial tax savings but requires careful planning. Following proper procedures ensures you meet eligibility requirements. Consult tax and legal professionals to understand all impacts.