From rental to primary home: Uncle Sam takes his cut

Depreciation recapture costs 25%

DEAR BOB: Is it necessary to make an Internal Revenue Code 1031 tax-deferred exchange before converting a rental house to my personal residence? Is there some way I can avoid that dreaded 25 percent depreciation recapture tax when I sell it? If I want to claim the $250,000 principal-residence-sale tax exemption, must I occupy it for 24 months and own it for 60 months? –Robert B.

DEAR ROBERT: If I understand your question correctly, you already own a rental house that you want to convert into your principal residence. Presuming it was not acquired in an IRC 1031 tax-deferred exchange, you can make it your personal residence at any time by kicking the tenants out (subject to their lease terms, of course) and moving in.

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To qualify for the Internal Revenue Code 121 principal-residence-sale exemption up to $250,000 (up to $500,000 for a qualified married couple), you must then occupy it at least 24 out of the last 60 months before its sale. There is no need to own the property 60 months unless it was acquired in an IRC 1031 exchange.

However, when you sell the property converted from a rental into your personal residence, the amount of depreciation you deducted after May 1997 will be taxed at the special 25 percent federal depreciation recapture tax rate. For full details, please consult your tax adviser.

CAN IRA FUNDS BE USED TO INVEST IN REAL ESTATE?

DEAR BOB: Can I invest the funds in my Individual Retirement Account (IRA) in real estate? –Tim H.

DEAR TIM: Yes. You can acquire investment real estate with funds in your IRA. However, you cannot use such funds to acquire your personal residence. To do this, you must have a self-directed IRA. For full details, please consult your tax adviser and your IRA trustee.

WHAT IS BASIS FOR INHERITED LAND?

DEAR BOB: I own farm acreage in South Carolina, and it is presently in coastal Bermuda grass. I obtained this property from my parents’ estate. If I sell it for $10,000 per acre for the 15 acres, what will be my capital gains tax? –Rau D.

DEAR RAU: Your adjusted cost basis is the fair market value of the property on the date you inherited the property. If you don’t know this vital valuation, hire a professional appraiser to establish your “stepped-up basis” of market value on the date of the death.

Your taxable capital gain will be the difference between your stepped-up basis and your adjusted sales price (gross sales price minus sales costs). The capital gains tax will be the current maximum federal capital gains tax of 15 percent, plus applicable state tax. For full details, please consult your tax adviser.

The new Robert Bruss special report, “2007 Realty Tax Tips: Eight Chapters of Tax Savings for Homeowners and Realty Investors,” is now available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com. Questions for this column are welcome at either address.

(For more information on Bob Bruss publications, visit his
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