From Homeowner to Landlord: The Tax Playbook You Didn't Know You Needed

How to turn your old home into a cash‑flowing asset without getting crushed by taxes

So you’re moving to a new place but can’t quite let go of your current home. Maybe the rental market’s sizzling, maybe you love that sunroom too much to sell, or maybe you just like money (valid). Before you slap a “For Rent” sign on the lawn, here’s the fun‑but‑serious tax plan to keep more of what you earn.

1) The Magic Moment: When Your Castle Becomes a Business

Why timing matters: The minute your home becomes “available for rent,” expenses start looking like business deductions (hello, Schedule E). While you still live there? Most costs are personal—no deduction.

Do this:

• Move out, take photos, and start actively marketing the property (listing, broker agreement, ad screenshots).

• Track dates. The conversion date controls when depreciation starts, what’s deductible, and how your sale later gets taxed.

Repairs vs. improvements: After conversion, routine fixes (leaky faucet, repainting) are usually deductible repairs. Bigger upgrades (new roof, new HVAC) are capitalized and depreciated.

Pro tip – Safe harbors worth knowing:

• De minimis safe harbor: Expense small-dollar items (subject to per‑item thresholds/documentation).

• Safe harbor for small taxpayers: In some instances, you can deduct some building expenses instead of capitalizing.

2) Depreciation at Conversion (Don’t Forget the Dirt)

When you convert to a rental, depreciate the lesser of (a) adjusted basis or (b) fair market value (FMV) at conversion—and exclude land (land isn’t depreciable). Use a defensible land‑to‑building allocation (appraisal, county ratios, or a reasonable method you can explain).

Example:

• Basis $420k (land $120k / building $300k).

• FMV at conversion $600k (land $200k / building $400k).

• Depreciation begins on $300k (the lesser building figure), over 27.5 years.

3) Your Big Deadline: The 2‑of‑5 Rule (a.k.a. the “Three‑Year Window”)

If you lived in the home for 2 of the 5 years before sale, you can generally exclude up to $250k of gain ($500k if married filing jointly) under §121—even after renting it. Many owners aim to sell within about three years of moving out to preserve that 2‑of‑5 window.

Bonus exceptions to know:

• Military/Foreign Service/Intel: You can suspend the 5‑year lookback for up to 10 years while on qualified extended duty.

• Partial exclusions for certain unforeseen circumstances (e.g., job change, health) may apply.

Calendar it: Set reminders for Months 24, 30, and 33 after moving out. Selling at 2y11m vs 3y1m can be a six‑figure swing.

4) The Sneaky Gotcha: “Nonqualified Use” (NQU)

Since the 2009 rules, some rental use can reduce your §121 exclusion. In short, periods of “nonqualified use”—generally when the property is not your primary residence after 2008 and before its last period of use as a principal residence—can prorate down the exclusion. (There are exceptions, including rental use after your last period of residence within the 5‑year window.)

Translation: If you rented the home for years **before ever living in it** and then moved in, you may not get the full §121 break later. Plan your timeline with NQU in mind.

5) The S‑Corp Shuffle: Powerful—but Handle with Oven Mitts

Concept: Sell the home to your wholly owned S‑corp before your §121 window closes. You get your $250k/$500k exclusion now; the S‑corp gets a stepped‑up basis to depreciate going forward.

What works about it: A bona fide FMV sale can “reset” depreciation higher, boosting annual deductions.

Serious cautions:

• Economic substance/business purpose are mandatory (real payments, market‑rate note, documented valuation).

• §1239 trap: Sales of depreciable property to a related party can turn some gain into ordinary income.

• Lender & title friction: Due‑on‑sale clauses, transfer taxes, reassessment, and insurance resets may be triggered.

• Entity fit: S-Corps are rarely ideal long‑term real‑estate holders (harder exits, distribution rules).

  
  

Bottom line: It can work, but it’s not a DIY move. Model cash flows, paperwork, and risk tolerance before you go there.

6) The 1031 Exchange: Your Tax‑Deferral Time Machine

Missed your §121 window—or want to keep snowballing into bigger properties? A §1031 like‑kind exchange can defer tax on investment property.

Must‑knows:

• Use a qualified intermediary (QI). You have 45 days to identify replacement property and 180 days to close. You can't touch the proceeds!

• The property must be held for investment (not a primary residence). Keep evidence of intent: leases, marketing, books/records.

• There’s no statutory minimum holding period, but many practitioners prefer 1–2 years for optics.

7) The “121 + 1031 Combo” (a.k.a. the tongue‑in‑cheek “1152 Plan”)

Yes, you can often exclude a chunk under §121 and defer the remainder under §1031. The ordering and basis mechanics are laid out in Rev. Proc. 2005‑14. In practice:

1. Convert to rental,

2. Sell while still §121‑eligible,

3. Take the §121 exclusion up to your limit, then

4. 1031 the **remaining** gain into a new property.

Caveat: Replacement must be investment property—don’t exchange into a home you plan to quickly occupy.

Example:

• Mort’s home is worth $1.1M with a $200k basis.

• He sells while eligible for §121, excludes *$250k, and 1031s the remaining $850k of gain.

• Hold long term and you’ve deferred a mountain of tax; hold until death and your heirs may receive a step‑up in basis.

8) Passive Activity Losses (PALs): The $25k Wildcard

Many first‑year rentals show paper losses thanks to startup costs and depreciation. By default, rental losses are passive—they offset passive income only.

The $25,000 special allowance:

• Up to $25k of losses can offset non‑passive income if you actively participate and your AGI < $100k.

• Phases out $100k–$150k. Over $150k AGI? The allowance is $0 and losses are suspended until you have passive income or dispose of the property.

• Married filing separately: Generally $12,500 if you lived apart all year, and otherwise *$0.

Fun but real math: In the phase‑out, every extra $2 of AGI can cost you $3 of taxable income (your $2 plus $1 of lost deduction) → a sneaky 150% marginal bite.

9) 3.8% NIIT & Other Overlooked Taxes

• NIIT (3.8%) doesn’t apply to §121‑excluded gain.

• A §1031 defers income tax and NIIT exposure on the deferred portion.

• State rules vary—check conformity to §121/§1031 and any transfer/recordation quirks for S‑corp moves.

10) Mixed Use After Conversion? Mind §280A

If you plan any personal use after conversion (e.g., owner stays a week between tenants), §280A can limit deductions. Keep clean lines: once it’s a rental, keep it a rental.

11) Your Action Timeline

Before Moving Out

• Get a valuation (supports FMV and land/building split).

• Photo‑document condition; list needed repairs (do the work after conversion when possible).

At Conversion

• Start marketing; save evidence it’s available for rent.

• Set up bookkeeping (income/expenses, mileage, home office if you manage from home, etc.).

Year 1–2 as a Rental

• Track active participation for the $25k allowance.

• Evaluate whether you want a 1031 later; keep records that show investment intent.

Approaching Month \~30–33 After Move‑Out

• Decision point: Sell (use §121), S‑corp transfer (advanced), or commit to long‑term rental + 1031 path.

• If selling, start early to close before your 2‑of‑5 year window expires.

12) Two Friendly Examples

Lois & Peter

• Bought for $300k**, now worth $1.0M. They move out and rent.

• By 2.5 years after move‑out, they sell at $1.0M.

• Gain ≈ $700k.

• Filing jointly, they can exclude $500k, pay tax on roughly $200k (subject to basis adjustments).

• If they miss the window by six months, they could be taxed on the entire $700k gain. Ouch.

Mort (the “1152” combo)

• Basis $200k, value $1.1M.

• He sells while §121‑eligible, excludes $250k (single filer), then 1031s the balance.

• Buys a larger rental, defers tax, enjoys higher depreciation, and keeps compounding.

The Bottom Line

This isn’t about picking one magic trick—it’s about sequencing:

conversion → depreciation → §121 timing → (maybe) S‑corp → (maybe) §1031.

With the proper order and documentation, you can keep five or six figures in your pocket.

If you want help tailoring this to your balance sheet and timeline, bring your numbers—we’ll model the options and paperwork so you can sleep at night.

*Disclaimer: This is general information, not tax advice. Tax laws and your facts change. Talk to a qualified advisor before acting. Also, yes, “1152 Plan” is a playful nickname—the underlying combo is real when done correctly (see Rev. Proc. 2005‑14).