I am considering leasing out my personal residence of the last 15 years on a two year lease. I purchased the house for $135,000 and invested approximately $50,000 on a full remodel and restoration. The current value is $225,000. I did not keep receipts as this has been my personal residence and I was not obligated to pay taxes on any profit. However, If I now lease the property, will I be obligated when I sell, to pay taxes on the profit over and above the original $135,000 plus expenses that I can document, or could I consider the present appraised value of $225,000 as my base?

ANSWER

The BIDaWIZ Team's Answer:

You may be able to utilize IRC Section 121 to claim a portion of the capital gains exclusion when you sell the property. Please note that any depreciation taken while the property is a rental will not qualify for the capital gains exclusion, and will instead be subject to depreciation recapture. In addition, the amount of the capital gains exclusion is generally allocated on a pro-rata basis in accordance with how long the property was considered qualified versus non-qualified. Renting the property is considered non-qualified use. So, since you will own the property for 17 years total and its a rental for 2 out of the 17 years, you may be eligible to exclude 15/17 of the capital gains exclusion which is $250,000 for singles and $500,000 for married couples filing jointly. In terms of the basis in the property, it is your original purchase price plus any additions. So, if you purchased the property for $135,000 and added $50,000 worth of modifications, your basis is $185,000. However, you need to provide supporting documentation for those remodeling expenses. The fair market value today has nothing to do with your cost basis when you sell it later on. Please let us know if you have any followup.