Purchasing a multi-family home is a great way to acquire a starter home and have the added benefit of receiving rental income to help out with the mortgage payment, taxes and maintenance. If the goal is to live in the property just long enough to build some equity and ownership experience, then you will face a tax decision at the time of sale.
Technically, a portion of the property has served as your primary residence and a portion as your investment property. For example, if the property is a three family and all of the units are of the same approximate size, then two-thirds of the property has been used for investment purposes and the expenses associated have been tax deductible during your ownership. At sale, only the one-third portion reserved for your personal residence will qualify for Section 121 tax exclusion and the remaining two-thirds is subject to state and federal tax. There are two levels of taxation to be aware of; recapture of previously taken depreciation and capital gains tax. On the Federal level, the first is taxed at 25%, the second at 15%. Depending on your state, the total tax can expose the sale to at 28-35% burden.
Three options should be considered; sell and pay the tax, hold the property and rent all of the units (no tax due until sale) or exchange the investment portion and defer the tax to some date far into the future. Exploring all of the options before sale will produce a better net value regardless of the course taken.
