Any suggestions or advice you can give me that would help me save on the taxes would be appreciated.
We’re not sure why you are trying to create a paper trail for something that didn’t exist. If you lived in your home for 20 years but only rented it out for the last three years, you can still take advantage of the tax law that allows you to exclude from federal income taxes any profits up to $250,000 ($500,000 if you are married) when you sell your primary residence. Among the key requirements is that you must have lived in the home as your primary residence for two out of the last five years.
You seem to meet the timing requirement. If so, even if you rented the property for the last three years, you still get the tax benefit. Now because you rented the home for three years, you may still have to pay some taxes on a portion of the profits for that time period, but you’d be able to exclude most of the profits from the sale of the home.
You’ll have to talk to a tax professional to go over the numbers and figure out what you will owe in taxes given the rental status of the home within the past five years. Also, we’re not sure that leasing the property to a tenant with a claim that they were renting-to-own (also known as lease with an option to buy) would help you in any way. In fact, claiming it retroactively could get you in trouble with the IRS.
You should also know that in a rent-to-own situation, you don’t get any of the benefits of a sale of the property until you actually transfer title to the buyer. In other words, during the months you rent the property — in a rent-to-own situation — you are still a landlord and the rent given to you will still probably count as income on your tax returns. Once the buyer closes on the property and receives a credit from you for the $200 per month toward the purchase price, you will account for those payments on your tax return differently.
While you weren’t clear on whether you had passed the three-year mark on renting your home, even then you might not be out of luck. When you sit down with a tax professional, you can look at all of your numbers and see where things stand. You owned the home for 20 years. You have to determine what the home cost you, what improvements you made to the home, what expenses you had to purchase the home and what expenses you will have to sell the home.
With this information, you’ll have a better idea of what your profit is from the sale of the home. Remember, you only pay taxes on the profit from the sale, not on the entire sale price.
Once you’ve really broken down the situation, you might find that the tax burden from the sale is not as much as you feared. While paying no taxes is always preferable, if you had to rent your home due to life-changing circumstances you may be entitled to a partial exclusion of gain from taxes.
People in the military, people suffering from unforeseeable events (death, divorce, unemployment, among others), health-related moves, work-related moves or other extenuating facts and circumstances may entitle a person to still get all or a portion of the $250,000 ($500,000 if married) exclusion from tax on the gain from the sale of the primary residence. Here again, you’ll need to talk to a tax professional to go over your situation.
You can also review some of the rules on the tax exclusion on the IRS website by searching for Publication 523. And, again, we strongly suggest you speak with your tax preparer.
Ilyce Glink is the creator of an 18-part webinar+ebook series called “The Intentional Investor: How to be wildly successful in real estate,” as well as the author of many books on real estate. She also hosts the “Real Estate Minute,” on her YouTube channel. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam at ThinkGlink.com.