1031 exchange


S

Spin

Hello experts,

I am a 58-year old widow who owns one home (currently renting that one) and
has a substantial mortgage on another (which I'm living in). I want to sell
the first home (which I own outright) partly due to the fact I cannot keep
up on it's maintenance. I do not want to move back into it and I have not
lived there for four years. I am considering a 1031 exchange and obtaining
an equal or higher value new condo in another state and rent that out. This
way I will not have to worry about exterior maintence. I will rent that out
which will help to pay for my current mortgage. I do not work as I am
living off the rental income of the first home and my inheritance. Does
that sound like a good plan?
 
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D

Dan G

Yup.
Or, sell the house on a contract and collect lot's of interest for 5-10
years that will more than pay the capital gains tax when it finally closes.
On a $200,000 house, you'll collect nearly $70k interest in 5 years at 7%.
Since you own it outright, you have several options. Maybe your current
tenant would even be interested in a deal. Contracts vary a lot from state
to state. You would still hold title, but would not be responsible for
upkeep. Even if they default, you will have made more than enough to pay for
the rehab needed to sell it again. Most of what you collect for the 5-10
years till it balloons will be interest. Taxable as regular income, but no
gains tax till it closes and you surrender title. Then, you can still buy
the next one and do it all again. You can make decent money on houses this
way even if you pay full retail for them.

Work the numbers and see how it works out for you.
 
S

Spin

Thanks. Regarding the 1031 exchange - I know I can sell the rental house
(which I own outright) and put the money into escrow and use the escrow
funds to buy and equal or higher value house. Now this is what I don't
know. I believe I have to show rental intent - by renting it out maybe at
least two weeks, then I can move into it, and sell the house I have a
mortgage and keep the $250,000 exemption. It's the second part I am not
clear on the tax law.
 
D

Dan G

There is no specific tax code regarding "intent". I've heard so-called
experts say anything from 6 months to 2 years of rental. It really depends
on the IRS investigator who's doing your audit. I'm pretty sure that "2
weeks" would not convince anyone. There's no rush to sell your current
residence either, you can rent it out for 3 years and still get the 250k
exemption.
 
A

Arthur Kamlet

There is no specific tax code regarding "intent". I've heard so-called
experts say anything from 6 months to 2 years of rental. It really depends
on the IRS investigator who's doing your audit. I'm pretty sure that "2
weeks" would not convince anyone. There's no rush to sell your current
residence either, you can rent it out for 3 years and still get the 250k
exemption.
Just to add:

1. assuming you can sell the house and place funds in escrow
might not be enough. Hire an exchange accommodator (if you have
pickedout the new property) or Qualified Intermediary to handle
all moneys.

2. Any home you acquire in a 1031 exchange is not eligible for Sec
121 exclusion for 5 years.
 
S

Spin

Since I have not lived in the house for four years, I believe I could also
move back for one year, and claim the 250,000 personal capital gains
exemption by meeting the 24-month occupancy test. What was that called, the
section 121 exclusion rule?

 
O

octogenerian

depending on the state property tax law, 1031 ex will bump up the tax
to current appraised value. In California, it could mean increase of
hundreds of dollars in monthly expense on the rental..
 
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Setting The Record Straight

There are a lot of questions and answers being thrown around here, so I thought I would chime in.

First, yes, your strategy seems sound. The key is that you would be selling property that requires maintenance and acquiring property that requires much less maintenance, and the 1031 Exchange would allow you to do so without incurring any capital gain or depreciation recapture taxes.

Second, you could move into the property and live there long enough so that you could say that you have owned it and lived in it as your primary residence for at least 24 months out of the last 60 months (2 out of the last 5 years). However, the 2008 Tax Act requires that the capital gain be prorated between the number of years that you rented the property and versus the number of years that you actually lived there as your primary residence, so you would not get the entire $250,000 tax free. The longer you live there, the more gain is tax free. This is referred to as the 121 Exclusion (Section 121 of the Internal Revenue Code).

Third, if you sell the property with Seller Carry Back Financing, you would be triggering your capital gain taxes and your depreciation recapture taxes. The depreciation recapture taxes are paid in the year of sale - no exceptions. The capital gain taxes can be deferred over the term of the note if properly structured, but you would be paying capital gain taxes over time. I'm not sure this is a good strategy for you, I think that the 1031 Exchange is probably better given what you have told us so far.

Fourth, one poster commented that there is no "intent" in the code. The Treasury Regulations (not the tax code) actually require that you have the intent to hold for investment (as opposed to held for sale). So, most experts, including us, recommend that you hold the acquire property as rental property for at least 12 months (not less than twelve months) before deciding to move into it. You may want to hold it as rental property longer if you are more conservative.

Fifth, another commentor indicated that renting the property for two weeks would not be enough. The IRS issued Private Letter Ruling 2008-16 which establishes a safe harbor for determining when the property would qualify for 1031 Exchange treatment if also use for personal use, vacation use, etc. The requires are three fold:
  1. Own the property for at least two (2) years; and,
  2. Rent the property for at least two (2) weeks out of each year; and,
  3. Limit your personal use of the property to (i) no more than two (2) weeks out of each year or (ii) no more than 10% of the number of days that you rent the property out.
I've tried to touch base on every comment, but please feel free to post a follow-up comment if you have any further questions.
 

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