USA Sale of Primary Residence Turned Rental


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Hello, I am new here so if this has been answered please let me know. I am a bit over my head but I will try to tell you the important things.

My husband and I lived in Ohio until he joined the military when we moved out of state. We always intended to move back to Ohio and our house when we were finished with his service. In the meantime we rented the house to my sister and her friend with the idea that they would get lower rent if they oversaw the property and paid the utilities. They moved out because the friend lost her job and they could not pay any rent. We picked up the rent on our Fed/Ohio return.

We then found someone else who wanted to buy the house but had to rent because of her financial position (she was saving for down payment). We were working through trying to get a land contract in place when she lost her job due to COVID. Because of the additional stimulus and extra unemployment she was able to continue paying us rent. We said to take her time and contact us when she wants to resume discussions on the land contract.

This week we found out she spoke to a realtor and basically sent us a contract for the sale of the house (FHA) which blind sided us. We have always picked up rental income appropriately and we have taken depreciation. I had researched how to do tax stuff for a land contract and we liked that because she's always a bit late on rent and we figured if she ever defaulted then we would get the property we love back instead of a bank (not that we expect a default). We were hoping to avoid going through a realtor because in our opinion they help you find the house/buyer and we already had that. The contract says she wants to close by December 20th of this year.

Now we find out we will be hit with thousands of dollars in closing costs and in addition, we bought the house for $130k and the purchase price is $180k. I know that we have to pick up all the depreciation that we took as recapture. We do not have the ability to buy new property and thus delay the payment on gains (which I don't even know if that would apply). Basically, while we picked up the income on the house we never treated it as investment property. We initially hoped to make it our residence and then we were leasing it in the hope of a sale - does that change how this transaction is treated? Will we need to pick up the full $50k gain in 2020? Is there anything I am missing? I feel like we will lose her if we say no and then have a house we can't afford to have empty or we do this but I'm not sure we'll be able to pay the taxes then! I am lost so I appreciate any help!
 
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Did you live in the house for 2 out of the last five years? If so you could take the Section 121 exclusion and not pay any gain. You are correct that you will have to recapture any depreciation that you took when the house was a rental.
If you do not qualify for the section 121 exclusion, remember that you can increase the basis of the house by any improvements. Plus you can decrease the gain by any expenses related to the sale. Lastly, its never a bad idea to have a lawyer and/or your realtor look over the contract and be sure that it is in proper order. This is protection and money well spent.
 
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Joined
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Did you live in the house for 2 out of the last five years? If so you could take the Section 121 exclusion and not pay any gain. You are correct that you will have to recapture any depreciation that you took when the house was a rental.
If you do not qualify for the section 121 exclusion, remember that you can increase the basis of the house by any improvements. Plus you can decrease the gain by any expenses related to the sale. Lastly, its never a bad idea to have a lawyer and/or your realtor look over the contract and be sure that it is in proper order. This is protection and money well spent.
Thank you for your response. I will have to look at the dates but we may well have lived there for 2 of the last 5 years and I will take a look at Section 121. We do not have a realtor. I am going to call around and see if we can talk to someone like a lawyer or CPA but as I mentioned they are a lot of money that we don't have right now. Again, thank you for your response.
 

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