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Because there are so many forms and schedules that have to do with the sale of real estate, I'm confused as to the best tax advantage in my situation.

During the next two years, I have the opportunity to sell one of my homes as either a second home, or as rental property. My basic question is: which way will provide the best tax advantage? Currently the home qualifies as a second home as my mother-in-law is living there rent free and has for the past two years. Previously the property was listed as rental property for two years. My mother-in-law is moving out of the house and I would like to sell the house within the next two years.

Is it best to sell now while the house is considered my second home, or rent it for two more years and sell it as rental property. I'm familiar with Schedule D which I assume I would use for sale of a second home, but not familiar with Form 4797, used for sale of rental property.
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I was just on the phone with the IRS asking about that area. Over an hour being passed around. I sold my second home (I didn't rent & sold at a loss, so it is $0 for a Sch D. I don't get to "use it" as loss againist income). one is SIMPLE as far as paperwork, one involes piles & or a history. I'm pretty sure you had to be along filing paperwork claiming income againist expenses, etc. (did you hang on to every recipt?). I'd call them, they don't ask who are.
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I don't know if the 3rd alternative is possible for you to do, but you could live in it for 2 years and sell it as your residence with no reported gain except for some possible unrecovered Sec. 1250 gain from its rental days.
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(some pertinent details snipped...)
Is it best to sell now while the house is considered my second home, or rent it for two more years and sell it as rental property?


If you're looking at a gain, it will make no difference - the gain will be taxed either way. However, if you will have a loss on the sale, you want the property to be a rental, not a second residence. That's because a loss on a second residence would not be deductible.

Remember, it will be the facts of the situation that dictate whether the house is a second residence or a rental. So you want as many facts as you can get to support a rental. Renting the house again after your MIL moves will certainly help support considering it a rental. And the longer you rent it out the better.

Finally, remember to consider the financial situation in addition to the taxes. If your crystal ball says the property is going to go down in value over the next couple of years, you may be better off selling now even if you don't get a tax benefit. You could lose more in the real estate investment than you would save in taxes. The only way to know is to run a couple of "what if" situations, then make your decision with that knowledge.

Good luck with your decisions.

--Peter
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