reduce taxes on house sale

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
metrunt
Posts: 130
Joined: Thu Jul 16, 2015 9:36 am

reduce taxes on house sale

Postby metrunt » Wed Jan 11, 2017 12:30 am

In the 1970s, my mother received a piece of property from her mother in law, likely valued at $40K then. In 2005, she sold it and bought a condo to us as a rental using a 1031 exchange. The condo only rents 8 months of the year and has only rented 7 or so years of the past 11. It's used as a vacation home or simply left empty the rest of the time.

She's looking at selling it now and I'm wondering if there's a way to reduce her tax bill. The sale price will be $340K or so. Her capital gains will be about $300K on the sale. Maybe $60K in taxes. She's not interested in converting it to her primary residence. One possibility is doing another exchange for a more easily rented house or duplex that I would manage. There shouldn't be any issues with that, right? Are there any other possibilities? What other properties can she buy? How can she reduce the tax if she takes the cash out?

Thanks!

Carefreeap
Posts: 1902
Joined: Tue Jan 13, 2015 7:36 pm
Location: SF Bay Area

Re: reduce taxes on house sale

Postby Carefreeap » Wed Jan 11, 2017 4:22 pm

The 1031 exchange can continue to defer paying taxes on the gain. Just make sure it's done right. I highly recommend using a CPA who does a lot of these.

The basics are that she needs to identify a similar property or properties that total the sales price or higher than the exchanged property, it has to be identified within 45 days of the sale of the exchanged property and escrow has to close within 180 days. I highly recommend that she use a professional facilitar so that she doesn't inadvertentaly make a costly error and take the cash directly. Also don't forget that the debt on the property has to be the same or higher as well. So she shouldn't pull out cash before the exchange.

A couple of thoughts about getting some cash; when we did our exchange several years ago we elected to take a little "boot" and paid the taxes on that. To get a "better' property than the one we wanted was going to cost us another $100k and we didn't want to stretch ourselves. Given that the market corrected three years later, we were grateful that we didn't take that risk.

She can also pull out cash AFTER the exchange and have access to the cash without paying taxes. BUT she mustn't forget that if she sells she'll still need to pay taxes on the total gain, not just her equity. That and depreciation, so she needs to make sure she leaves herself enough cash.

There are a couple of red flags she should be aware of. One is that for a property to be classified as a rental property you cannot have more than 14 days of personal use per year. Personal use would include letting friends and family use it without charge. There are some exceptions (like staying at the property to work on it) but she should keep a log of personal use in case she's audited. Not renting for a year sure sounds like a conversion for personal use.

metrunt
Posts: 130
Joined: Thu Jul 16, 2015 9:36 am

Re: reduce taxes on house sale

Postby metrunt » Thu Jan 12, 2017 1:21 pm

Thanks for the reply.

I don't remember the rules on personal use when we first did the 1031, are those relatively new? It's definitely been a investment property, but it hasn't rented well, people seem interested, but then back out, or want it for shorter terms. I think the agent isn't very good, but I'm not involved in that side of things. While the intent has been investment, she might be on the wrong side of the 14 day rule. We haven't been documenting her stays, vs empty waiting for rental.

I will definitely work with a CPA on this.

*When you take out 'boot' do you pay taxes on the total amount (above the base price) or a pro-rated amount? Or some other figure?

curmudgeon
Posts: 1147
Joined: Thu Jun 20, 2013 11:00 pm

Re: reduce taxes on house sale

Postby curmudgeon » Fri Jan 13, 2017 12:56 am

When you take out "boot" in a 1031 exchange, the total amount taken out is taxable (unless it exceeds the gain, but then there wouldn't be any point to the exchange). Taxability is a "worst first" model, so the first part of the boot would be recapture of depreciation, then long-term cap gains. You can also get "boot" by having a mortgage paid off in the sale, but it doesn't sound like that would apply here.

Lots of odd rules and limitations in 1031, so it pays to look and plan carefully before jumping. Another option could be a "Charitable Remainder Trust", if you have a combination of income needs and charitable intent. Depending on the specifics, sometimes the donor could end up with pretty much the same net vs paying the LTCG/recapture taxes, and support a charity as well.

Carefreeap
Posts: 1902
Joined: Tue Jan 13, 2015 7:36 pm
Location: SF Bay Area

Re: reduce taxes on house sale

Postby Carefreeap » Fri Jan 13, 2017 11:41 am

curmudgeon wrote:When you take out "boot" in a 1031 exchange, the total amount taken out is taxable (unless it exceeds the gain, but then there wouldn't be any point to the exchange). Taxability is a "worst first" model, so the first part of the boot would be recapture of depreciation, then long-term cap gains. You can also get "boot" by having a mortgage paid off in the sale, but it doesn't sound like that would apply here.

Lots of odd rules and limitations in 1031, so it pays to look and plan carefully before jumping. Another option could be a "Charitable Remainder Trust", if you have a combination of income needs and charitable intent. Depending on the specifics, sometimes the donor could end up with pretty much the same net vs paying the LTCG/recapture taxes, and support a charity as well.


I remember paying Fed & State cap gains but not depreciation. It wasn't much money; maybe 10k-20k. But I could be wrong. It's one reason we keep our CPA. She's very good with keeping up with the rule changes and giving us a head's up.

In hindsight it probably would have been smarter to have paid a little more and set aside an escrow fund of some kind to do such much needed cap improvements for a then 35 year old house. Live and learn! (Although it did work out in the end when we sold the property and added it to our basis. We would have wound up paying taxes on it one way or the other.)


Return to “Personal Finance (Not Investing)”