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Investment income or not?


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#1 Corey.Wright

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Posted 29 September 2009 - 02:27 PM

If a home owner leases a home for more than 2 years it is considered investment income when he sells it correct? This was brought up to me by a seller during a cold call.

#2 Dave T

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Posted 30 September 2009 - 12:35 AM

Corey,

A little more context would be helpful. We need to know what the homeowner thinks investment income is. Also, it is not clear from your question whether the homeowner is the renter who eventually buys the property he occupies as his primary residence or the landlord for property he currently owns that has been converted to a rental.

My response assumes the latter.

As far as the IRS is concerned, there are three main categories of income:
  • Active income which is income for which services have been performed. This includes wages, tips, salaries, commissions and income from businesses in which there is material participation.
  • Passive income is the earnings an individual derives from a rental property, limited partnership or any other enterprise in which the taxpayer is not actively involved.
  • Portfolio income is the income from investments, including dividends, interest, royalties and capital gains.
As a general rule, the profit from the sale of real estate you own, whether used as your primary residence or held for investment or for business use, gets capital gains tax treatment and would be considered portfolio income. Does not matter how long the property was used as a rental, the sale profit gets capital gains tax treatment.

I suspect the homeowner you were talking to was really concerned about the capital gains exclusion on the sale of his primary residence if it has been converted to a rental property prior to the sale. As you know, Section 121 of the tax code allows homeowners who sell their primary residences to exclude their sale profits from capital gains tax treatment if the taxpayer has owned AND occupied the property as his primary residence at least two of the five years prior to sale.

The five year window looks backward from the date of sale. As long as the taxpayer has occupied the property as his primary residence at least two of the five years prior to sale, AND has owned the property at least two of the five years prior to sale, he qualifies for the capital gains exclusion. Does not matter how the property was used for the other three years of the five years prior to the sale. The taxpayer can occupy for two years, rent out the property for almost three years before selling the property, and still qualify for the capital gains exclusion.

However, once the property is used as a rental for more than three years of the five years prior to the sale, the property is no longer a primary residence and becomes an investment property. The consequence is that the profit is taxed as the sale of an invesment property and can not be excluded from capital gains taxes as the sale of a primary residence.

Does this help?

#3 Corey.Wright

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Posted 30 September 2009 - 08:05 PM

Holy Moly. Michael told me to post it in here because you were the tax guru. And he was sure right. Thank you for the in depth explanation. Thats what I was looking for. Thanks

#4 Nick

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Posted 03 December 2009 - 10:14 PM

I know this may be a little basic, but is profit just the difference between purchase and sales price? Or are other factors like deprecation, or mortgage amount, taken into account?

#5 DustinDal

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Posted 18 February 2017 - 11:59 AM

The same methods like with other investment assets: buy cheap and take profit. However bitcoin has good fluctuation of the price so if you choose a correct moment you can earn good money quickly.




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