Converting a rental into a primary residence is not a function built into Moneytree Plan, but can be modeled thanks to Moneytree Plan’s flexible plan data. To model a rental to residence conversion “sell” the rental to stop the income, expenses, and taxes. After that, offset the taxable gain reported from the “sale”of the property. From there, “purchase” the residence to offset the proceeds from the “sale” of the rental and add the residence to the clients’ net worth.
Converting a rental into a primary residence:
Step 1: “Sell” rental at time of conversion to primary residence.
- Show the rental as sold to stop the associated rental income, expenses and taxes.
- Enter adjustments to offset taxes due on the “sale” of the property.
Step 2: “Purchase” a residence.
- This will add the home value to the yearly net-worth report and handle any remaining mortgage on the property.
- The cost of “purchase” also offsets the proceeds from the “sale” of the rental property.
Example Rental Conversion Case for Prosper Reports:
For this example, let’s look at clients planning to sell their current residence in 5 years, then moving into a rental property they own. Individual 1 is 55 years old. They pay off the residence mortgage, then they reinvest the net proceeds from the sale. The mortgage on the rental property, once converted into a primary residence, remains unchanged.
Residence Sale:
Selling the residence in 5 years is simple. Just enter Individual 1’s age of sale in the residence asset data.
The mortgage is paid off with the sale automatically when the mortgage is tied to the residence being sold.
Any remaining proceeds after the mortgage payoff (and potential taxes) will be available for reinvestment.
Also see: 5 Common Residence Sale Scenarios in Moneytree Plan
Converting Rental to Primary Residence:
Modeling the conversion of a rental to a residence takes some time and manual adjustments. Start by running the reports with the rental property entered. Go to the summary report for the specific property (G1a, G2a, G3a, etc.). Since there is only one property in this example, the report page is G1a.
The rental property report allows us to determine two values needed for step 2 of the conversion:
- Mortgage value as a percentage of property value the year of conversion.
- Number of years remaining on the mortgage.
To keep the numbers clear for this example the information included in the reports are for the rental conversion only. The current residence has been removed for the purpose of this illustration.
For this example, the conversion is occurring in 5 years, at Individual 1’s age 60. At the time of conversion, the market value of the rental is $441,632 and the mortgage balance is $158,839.
- Mortgage value as a percentage of property value is 35.97%.
- There are 19 years remaining on the mortgage at the clients age 60.
With these values in hand, move to step 1 of the conversion which is to “sell” the rental, stopping the income, expenses and taxes associated with renting the property.
Step 1: “Sell” rental at time of conversion to residence.
- Enter the sale of the rental property, by providing the age at sale, in this example Indvidual 1’s age 60. This stops the associated rental income, expenses and taxes.
- With the sale entered, run the reports to get the values needed to make adjustments to offset the taxes due on “sale”.
- Go to the Income & Tax Analysis for the rental property (Property 1 Income – G1b in this case). The capital gain on sale (column 9) and the unrecaptured section 1250 gain (column 10) need to be manually offset.
- The capital gain from sale flows to Taxable Income Analysis (report D7 in Prosper) as capital gains. To offset the capital gain, go to the Tax Details tab within the tax section of the Plan Data and select “Schedule D Capital Gains / (Loss). In the future changes table, enter Ind. 1’s age of “sale” and the amount of capital gain generated from the “sale” as a negative amount in the tax report column. In this example, the entry is age 55 with an amount of ($191,632). Enter the client’s age the following year with an amount of 0 to indicate it is a single year adjustment
- The section 1250 unrecaptured gain from sale flows to the Taxable Income Analysis (report D7 in Prosper) as other taxable income. To offset the unrecaptured gain, go to the Tax Details tab within the tax section of the Plan Data and select “Other Taxable Income / (Loss). In the future changes table, enter Ind. 1’s age of “sale” and the amount of unrecaptured gain generated from the “sale” as a negative amount in the tax report column. In this example, the entry is age 55 with an amount of ($83,636). Enter the client’s age the following year with an amount of 0 to indicate it is a single year adjustment.
The tax report entries will flow to the Taxable Income Analysis, offsetting the capital gain and unrecaptured gain.
Taxable Income Analysis before tax offsets:
Taxable Income Analysis after tax offsets:
Step 2: “Purchase” a residence at time of conversion.
In this example, 2 options are available to model the “purchase”:
- Use the residence replacement fields for the current residence, since the conversion occurs in the same year as the primary residence sale. This does not work if the appreciation on the current residence is not the same as the rental property’s.
- Create a new residence with a current value of $0 and an appreciation rate equal to the rental property. From there, use the residence replacement field to enter the details for the “purchase”. The image below uses this method.
Reviewing the Results:
With the tax impact offset, the net results of “selling” the rental property and “purchasing” the residence will be a wash.
For the example case, the proceeds from the rental property “sale” amounts to an income of $282,793, and the down payment resulting from the “purchase” amounts to an expense of $282,777.
Rental property “sale” income:
- Market value $441,632 less mortgage of $158,839 = $282,793
Residence “purchase” expense:
- Net proceeds amount to the down payment cost = ($282,777)
- The “new” mortgage can also be seen on the residence sale worksheet (report B21 in Prosper), equaling the mortgage remaining on the converted rental property.
Reviewing the Net Worth (report F6 in Prosper) shows a steadily appreciating real estate market value and declining mortgage balance according to schedule.
