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Saturday, June 25, 2005 - Page updated at 12:00 AM

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Avoiding capital gains-taxes on rentals

Seattle Times staff reporter

Q: I've always understood that you could avoid paying capital gains on your rental property by moving in and making it your principal residence for two years before selling it.

Recently I heard this is no longer the case, and now you have to live there five years. Is this true?

A: It's partially true, says enrolled agent Forrest Waters, owner of Forrest Waters Tax Service in Kent. (An enrolled agent specializes in tax accounting and preparation.)

The timeline depends on how you acquired the property, Waters says.

If you bought it as a straightforward investment, rented it for a while, then moved in, two years in residence will do the trick to avoid paying capital-gains tax.

However, if you acquired your rental though a 1031 like-kind exchange, you no longer can avoid capital gains by living there two years.

Such an "exchange" allows an investor to sell one investment property — often one whose tax benefits have been mostly used up — and buy another.

This must be done strictly according to IRS rules, which recently extended the two-year residency requirement to five years.

Owners who "exchange" property in such a way can sell if they haven't lived in the home for five years, but they will have to pay capital-gains tax on any profit realized from an investment property.

Waters says this may make 1031 exchanges less attractive to some investors.

However, "if you legitimately want to get out of one property and into another, a 1031 exchange is still a great way," he said. Any depreciation taken on the property since 1997 must be recaptured, which in a nutshell means some taxes will be due.

Q: My neighbor is adding a gas line to his home and wants to tap off my gas line instead of tapping from the street.

If he taps from the street, it takes 90 days to get a permit. If he taps from my line, it can be done in 10 days.

Are there any legal or other implications I should be concerned about?

A: Dorothy Bracken, spokeswoman for Puget Sound Energy, was surprised to hear of a 90-day wait to get a permit. After checking around, she found no one at PSE who'd heard of it taking that long.

Still, tapping into your gas line might be a good way for your neighbor to go — and get you some good-neighbor points in the bargain.

Your neighbor, of course, would have his own gas meter.

"Depending on distance, soil conditions, terrain and other factors, installing a twin natural-gas service line to a home adjacent to the existing meter can be a very efficient way to obtain gas service," Bracken said.

It's cheaper than installing an individual gas line, and there's no need for an easement "because the natural-gas service lines and natural-gas meters are the property of the utility," she said.

After your neighbor calls PSE's customer construction line (888-321-7779), a representative will evaluate whether installing gas in this manner is feasible.

"It may not be possible to do twin service if there's a rock wall, a terraced slope or other barrier," Bracken said.

The cost varies from property to property, depending on such factors as the length of the gas line and whether a sidewalk is involved.

Any work on the gas line would have to follow PSE rules, Bracken said.

For example, during the work, the line to your house would be shut off.

Once it was back on, a PSE service technician would have to enter your home to relight natural-gas appliances.

Addendum: Several readers responded to a recent column item about how to deal with a cat digging in a neighbor's flowerbed.

A woman in Freeland, Island County, suggested grinding up citrus rinds and sprinkling them in the area where cats are not welcome.

"The rinds need to be renewed periodically, and I find them still effective even if I've frozen the ground-up rinds first," she wrote.

Another reader suggested that laying out rough bark, rocks or other course matter in the garden would deter cats.

That reader suggested a Web site for more ideas: www.neighborhoodcats.org/info/keepingout.htm. Among the suggestions found there: a motion-activated sprinkler.

Home Forum answers readers' real-estate questions. Send questions to Home Forum, Seattle Times, P.O. Box 1845, Seattle, WA 98111, or call 206-464-8510 to leave a question on a recorded line. The e-mail address is erhodes@seattletimes.com. Sorry, no personal replies. More columns at www.seattletimes.com/columnists.

Copyright © 2005 The Seattle Times Company

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