A common scenario is that when an individual (or family) moves to a new house, the old house is rented out rather than sold. What happens in that case is called a “change in use”, the old house changed its purpose from being used as a principal residence to a rent income producing property. This change in use triggers a deemed disposition and a gain is calculated between the original purchase price and the fair market value at the time of the change of use. The property could fall under the principal residence exemption so no actual tax is paid on the deemed disposition. If the rental property is sold 2 years later then the gain is calculated between the sales price and the fair market value of the property at the time of the change in use. There’s an election available which allows the property to still be designated a principal residence for up to 4 years following the change in use, provided that no deduction is taken for amortization when calculating the rental income from the property. Filing this election means that the new house or the old house (up to 4 years) can be used as a principal residence and is eligible for the exemption.
There’s also the possibility that the opposite happens. An individual (or family) move into a housing property which was previously rented out. In this scenario, there’s a deemed disposition for the property. There’s an election available which could defer the gain on the change in use until the property is ultimately disposed of.
There are a number of factors to consider when making the decision to designate one property over another as a principal residence. Things like potential gain in the future, current tax liability and the length of time the property has been owned or will be owned are all factors which could significantly impact the decision.
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