The idea of converting a primary residence to an investment property has always had a certain appeal. Under the previous rules, there was an incentive to convert residential to investment property. By doing so. you could sell and execute a 1031 exchange, thus deferring the gain. However, with the 1997 changes, it is no longer necessary. An entirely different incentive has been created: to convert investment property into residential, use it as a primary residence for at least two years, and then sell it tax-free (except that depreciation is taxed upon sale in that instance).

If you invest strictly in single-family properties, this is possible. However, you cannot convert a five-unit apartment building to your residence and qualify under the new rules. Some situations are not affected. But, for the many people who deal only in rental houses, the new rules present some long-term planning opportunities.

For example, some investors allow rental houses to go unpainted for a few years, planning to update when they're ready to sell. But now that primary residence gains are free of federal income tax, those same investors have a good incentive to move into their rental properties. It's much easier to complete cosmetic repairs while living in the house. These can include painting in and out, putting on a new roof, upgrading plumbing, installing new floors, and many other improvements designed to add value. This makes sense in anticipation of putting the property on the market.

The new tax rules have liberalized and simplified the requirements for homeowners. You need to live in a house for only two years to call it your primary residence. If you sell, the profit is not taxed (up to the limit of $500,000 for married couples and S250.000 for single people).

To be sure you qualify for the rules of deferral for investment properties, or simply to identify the amount of profit on income property, you need to be sure you're keeping accurate and complete books. For many people, bookkeeping is a little less desirable than root canal work. But by keeping it simple, you can also minimize the time commitment and the pain of having to keep records. To become a successful investors, you need to learn to keep an accurate but simple set of books.

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