I have kind of a sticky situation. My wife and I have jointly owned our primary residence (let’s call this property A) since 1996 and have built quite a bit of equity in it. We recently decided to purchase a bigger place (let’s call this property B) and rent property A. I have three tax related objectives in this transaction:
Protect my capital gains tax exemption (part 121 I think it’s called) that I have built to this point on property A should I decide to sell it at some point after it has been a rental (not our primary residence) for 3 years.
Get my basis on property A as high as possible to maximize the tax benefit from depreciation. This would also help with objective 1 in that it would “reset” the capital gains basis.
Refinance property A and use the proceeds to purchase our new primary residence (property B) and have the interest on this new mortgage be expensible, that is, be able to treat it as an expense to offset the rental income.
I’ve talked to several people and all tell me I’m essentially screwed on this. They say that my basis must be calculated from the original purchase price plus capital improvements and that if I use the proceeds of the refinance for purposes other than directly related to the rental (property A) then I won’t be able to expense the interest OR deduct the interest.
What really gets me is that if I were to SELL property A and use the proceeds to purchase property B, and then go out and purchase an investment property of the same value as property A (I could even repurchase property A for that matter) and take a mortgage on it, I would essentially achieve all three objectives. The problem with this is that first, I would rather not sell in this market and second, I like property A and plan to turn it into a part time vacation home at some point in the future and maybe even turn it back into our primary residence once the kids are grown and out of the house.
Can anyone think of a way to achieve these objectives without selling property A? Is there some sort of way to do an “arms length” transaction in order to achieve this? I’m not trying to beat the system here, I’m just trying to stop it from beating me.
Thanks in advance for any help!