Sale of Rental Converted To Personal Residence


R

Ron Sheldon

In Sept. 1982 I purchased a townhouse as a rental property,
which converted to my residence in March 2001. I now own
the property without a mortgage and I'm considering the
property, but would like to do in a tax efficient manner.
Some financial information may be helpful:

Original Cost Basis, Sept. 1982, $70,000 [$20K land, $50K
structure fully depreciated Sept. 1997, 15 yr ACRS]
Capital Improvements, various dates, $8,000 [minimal
depreciation before and after May 7, 1997 until conversion
to residence, e.g., $2,000]
Capital Improvements after conversion to residence until
sale, $18,000
Estimated Net Selling Price, after RE commission and
settlement costs, $450,000

Here is how I believe taxes would be computed:

Net Selling $450,000
Less improvements 24,000
[both undepreciated while rental and as residence]
Less original land 20,000

Gain $406,000

Recapture of Depreciation @ 25% Fed and 5.75% VA state
Personal Exemption -- $250,000 [I'm single] with no Fed. or
VA state tax
Remainder @ 15% Fed. LT Cap Gains rate and 5.75% VA state
rate [VA mostly conforms to Fed. but doesn't distinguish
between most types of income]

Questions:

Is the above essentially correct? Please clarify/correct
any errors.

Is all depreciation subject to recapture or only depreciation
after May 7, 1997?

I do not have a need for cash from the sale and would be
willing to hold an interest only note for up to 10 years as
an installment sale. This to me seems a way to keep the
fully proceeds from sale working for me and defer the tax
consequences until the note is paid off, versus investing
the net proceeds after taxes.

Questions:

For an installment sale is an interest only note okay or do
I need to have the note be amortized?

Will I retain the $250,000 personal exemption based on the
date of the installment sale, even if tax law changes during
subsequent years [barring games by Congress, of course]?

If I should die before the installment sale note is paid
off, would my heirs inherit the note with a stepped up basis
based on selling price and avoid recapture and cap gains
taxes?

I have a Roth IRA with adequate funds to purchase the
property out right or as above and I understand there are
arrangements/firms for IRAs to hold real estate, but I have
yet to explore this option. I also understand my IRA is a
separate legal entity from myself and that it affords
certain protections from personal liability, etc.

Questions:

Could I sell my property to my Roth IRA as an installment
sale as above but with certain adjustments, e.g., no RE
commission, a supported/documented value different/less than
the $450,000 I estimate the property might sell for?

Use the appreciated value of the property in the Roth IRA to
acquire other positive cash flow income producing
properties?

Can I have the Roth IRA rent the property with rents, future
appreciation, etc., tax free until a tax free sale or
inheritance with continued tax free benefits to my heirs?

Could I rent the property myself from the Roth IRA [and,
probably, have the Roth IRA rent it to others later] at a
rental rate greater than interest payments on the note from
Roth IRA to me as an indirect way to increase funding of the
Roth IRA -- I no longer have earned income to make direct
contributions to the Roth IRA -- and as a way to achieve the
same potential benefits as in previous question?

I will appreciate your answers and thoughts on the above and
other helpful options you might suggest.

Thanks,

Ron Sheldon
 
Last edited by a moderator:
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D

D. Stussy

Ron said:
In Sept. 1982 I purchased a townhouse as a rental property,
which converted to my residence in March 2001. I now own
the property without a mortgage and I'm considering the
property, but would like to do in a tax efficient manner.
Some financial information may be helpful:

Original Cost Basis, Sept. 1982, $70,000 [$20K land, $50K
structure fully depreciated Sept. 1997, 15 yr ACRS]
Capital Improvements, various dates, $8,000 [minimal
depreciation before and after May 7, 1997 until conversion
to residence, e.g., $2,000]
Capital Improvements after conversion to residence until
sale, $18,000
Estimated Net Selling Price, after RE commission and
settlement costs, $450,000

Here is how I believe taxes would be computed:

Net Selling $450,000
Less improvements 24,000
[both undepreciated while rental and as residence]
Less original land 20,000

Gain $406,000

Recapture of Depreciation @ 25% Fed and 5.75% VA state
Personal Exemption -- $250,000 [I'm single] with no Fed. or
VA state tax
Remainder @ 15% Fed. LT Cap Gains rate and 5.75% VA state
rate [VA mostly conforms to Fed. but doesn't distinguish
between most types of income]

Questions:

Is the above essentially correct? Please clarify/correct
any errors.

Is all depreciation subject to recapture or only depreciation
after May 7, 1997?
All. Depreciation occured while NOT your residence. The
pre-1997 depreciation is ignored ONLY when it occurs as a
result of business use of your home.
I do not have a need for cash from the sale and would be
willing to hold an interest only note for up to 10 years as
an installment sale. This to me seems a way to keep the
fully proceeds from sale working for me and defer the tax
consequences until the note is paid off, versus investing
the net proceeds after taxes.

Questions:

For an installment sale is an interest only note okay or do
I need to have the note be amortized?
Your choice - but an interest only note will have a baloon
payment due at the end for all the principal - and would the
buyer be able to do that? However, for installment sale
reporting, you must prorate gain and interest over the life
of the period involved. Form 6252 does that for you.
Will I retain the $250,000 personal exemption based on the
date of the installment sale, even if tax law changes during
subsequent years [barring games by Congress, of course]?
Yes. The ratio of gain (and interest) is based on the selling
year.
If I should die before the installment sale note is paid
off, would my heirs inherit the note with a stepped up basis
based on selling price and avoid recapture and cap gains
taxes?
No. See "income with respect to a decedent."
I have a Roth IRA with adequate funds to purchase the
property out right or as above and I understand there are
arrangements/firms for IRAs to hold real estate, but I have
yet to explore this option. I also understand my IRA is a
separate legal entity from myself and that it affords
certain protections from personal liability, etc.

Questions:

Could I sell my property to my Roth IRA as an installment
sale as above but with certain adjustments, e.g., no RE
commission, a supported/documented value different/less than
the $450,000 I estimate the property might sell for?
No. It must be an "arm's length" transaction to have a
chance of not being considered a disguised distribution.
Use the appreciated value of the property in the Roth IRA to
acquire other positive cash flow income producing
properties?
Nonsensical question. Appreciated value does not yield cash.
Can I have the Roth IRA rent the property with rents, future
appreciation, etc., tax free until a tax free sale or
inheritance with continued tax free benefits to my heirs?
No. At some point, the required minimum distribution for an
inherited Roth IRA would cause a necessary sale.
Could I rent the property myself from the Roth IRA [and,
probably, have the Roth IRA rent it to others later] at a
rental rate greater than interest payments on the note from
Roth IRA to me as an indirect way to increase funding of the
Roth IRA -- I no longer have earned income to make direct
contributions to the Roth IRA -- and as a way to achieve the
same potential benefits as in previous question?
No. Self-dealing/related entities => distribution.
 
Last edited by a moderator:

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