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The IRS makes a distinction between property that a taxpayer lives in and property that he rents out to others, even if both are within the same building. You need to understand this distinction and its tax implications.
For example, suppose that you've owned and lived in a home for a number of years. Your house has an attached rental unit that you rent out. You've claimed depreciation deductions for the rental portion of your property on your annual income tax return. Suppose further that the rental unit accounts for about 25 percent of the total living space of the building. When you sell the property, the IRS treats the sale as two separate transactions - the sale of your primary residence (the 75 percent portion of the property) and the sale of a rental property (the other 25 percent portion of the property).
As for the profits on the rental portion of the property, you owe capital gains tax on those profits unless you buy another building with a rental unit that meets the particular requirements that we discuss in the next section.
- Keep Copies of the Closing and Settlement Papers
- Keep Proof of Improvements and Prior Purchases
- Stash Your Cash in a Good Money Market Fund
- Double-check the Tax Rules for Excluding Tax on Profits
- Cast a Broad Net When You Consider Your Next Home
- Remember That Renting Can Be a Fine Strategy
- Reevaluate Your Personal Finances When Things Change
