Couple should seek insight into rental-property concerns

Ilyce Glink and Samuel Tamkin

Q: My parents are elderly and live in Virginia. They own a rental house in California. Since they bought it, the home has increased greatly in value to about $1 million. They are trying to decide whether they need to live in the home for two years before selling it, in order to avoid capital gains taxes.

My father is very ill, so a major change would be difficult.

A: With home values this large, your parents might benefit from the advice of an attorney who handles estate planning.

Even if your parents lived in the home for two out of the past five years, they would only be entitled to exclude from federal income taxes $500,000 as a married couple. (Individuals can exclude $250,000.)

If your parents purchased the home for $250,000 and now it’s worth $1 million, they have a profit of $750,000. (We’re making this simple and not including costs of buying or selling the home.) The IRS would permit them to avoid any taxes on $500,000, but your parents would still have to pay capital gains taxes on $250,000.

Because you indicated that it was a rental property, they would pay capital gains taxes on $750,000. But it gets complicated.

We don’t think it’s realistic for your parents to try to move to California. Even if they started using the home as their primary residence and lived there for two years so that the IRS would consider the home their primary residence, the fact that the home was an investment property would require your parents to pay capital gains taxes on the profit anyway.

They probably would not be entitled to take the full advantage of the $500,000 primary-home exclusion, as the IRS would require them to consider the time the home was an investment property and the time the home was a primary residence.