Q: I have a condo in which I lived for five years before converting it to a rental. Now, I would like to make it my second home. What kind of capital gains tax consequences will I face when I sell the property?
A: Two tax traps lurk in your future if you proceed with your plan. First, the cost basis of the home must be reduced by the amount of depreciation you declared on the home when it was a rental.
This will effectively increase your taxable gain. Further, once you make the unit your second home, profits are fully taxable upon its sale.
You are not entitled to defer gains by buying another residence, as with sale of a principal residence. Nor are you entitled by law to exchange the second home for another piece of investment property, as you would if you kept the home as a rental.
Clearly, your plan is fraught with negative tax implications. Perhaps, our experts suggest, you should consider exchanging your condominium now, while it is still a rental, for another piece ,, of investment property.
This second piece of property could be a potential second home, if that is what you want. Rent it for a while -- at least six months, but a year or more would be preferable.
Then you can convert it to your second home. However, if and when you sell this home, you will face a tax bite.