Yes … and No - Posted by Dave T
Posted by Dave T on February 12, 2001 at 01:49:23:
The tax code does allow you to convert an investment property to your principal residence. Then if you meet the 2 year ownership and use requirements, your profit on the sale is eligible for the capital gains exclusion on the sale of a principal residence.
Now the interesting part of the question is who gets the tax treatment. Assume that only you occupy the house as your principal residence for two years, then sell the house. Your share of the profit would qualify for the capital gains exclusion, however, you sister’s share would be taxed as ordinary income on the sale of a second home.
If, instead, your sister continued to rent out her share of the house while you occupied your share as your principal residence, then upon sale her share of the profit would receive capital gains tax treatment on the sale of investment property. Of course, this assumes that she does not use a 1031 exchange to defer her capital gains taxes.
Let’s go a little further with this example. Let’s say that you occupy your share of the house as your principal residence for two years then move out. Now let’s say that your sister moves in and occupies the house as her principal residence for two years, THEN the property is sold. Now both you and your sister are each eligible for a $250K capital gains exclusion on your respective shares of the profit from the sale – even if you rented out your share of the house for the two years that your sister occupied her share as her principal residence. Any depreciation taken (or that should have been taken) simply reduces your adjusted basis (and increases your profit) in the property.