1031 *plus* Section 21 $500k exemption on same property

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1031 *plus* Section 21 $500k exemption on same property

S Siler
Member since 2020 · 1 post · 0 votes

Hi all. We're planning on selling a home that we used to live in. We can take the Section 21 tax exemption ($500k tax-free). But we'd also like to do a 1031 exchange. Now, I've talked to three (THREE!) accountants, and every single one had a different answer. Let me give you the scenario. 

Home purchased for $660,000

Assume depreciation of $30,000

Did about $150,000 of upgrades over the years

Mortgage is about $400,000

HELOC is about $50,000

Let's say the home sells for $1.63M just to make the math easy (although it will likely sell for more).

SOOOOOO....

How much money do we have to put into the new property when we do the 1031?

(1) $1.63M minus closing costs minus $500,000 (because we can take that as cash, tax-free, and it doesn't count as boot), with a loan of at least $450,000 b/c that's how much we had outstanding on the current property

(2) Only the net (let's just say like $1M, forgetting about closing costs right now, just for math's sake), minus $500,000 (because we can take that as cash, tax-free, and it doesn't count as boot), so that's about $500k that must be rolled into the new qualified property... plus we need a loan of at least $450,000 b/c that's how much we had outstanding on the current property, so we're looking at a property of about $950k-ish

(3) A totally different amount

THANK YOU

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    @S Siler it will become clear if you turn the scenario around a little.  Here's the facts

    1. If you sell a property that you purchased as your primary residence and have lived in for two out of the 5 years prior to sale you are eligible as a married couple to take the first $500K of gain tax free.  Because it started as your primary there is no proration.  You are eligible for the full exemption of sec. 121.

    2. Because it is now an investment property it qualifies for sec 1031 treatment.  You can sell it and purchase a property of equal or higher value and by doing the 1031 process you get to defer all tax on gain and depreciation recapture.

    Both of these criteria are met it sounds like.  So How can you make them work together.

    1. The 1031 has no exception for not reinvesting part of the proceeds.  If you take money it is called boot and is normally taxable.  Notice I said normally.  It is reported on the form 8824. It affects your schedule E. 

    2. Taking the 121 exemption goes on your schedule E.  The 1099 is reconciled against the exemption and reported on the form 8949.   Topic 701 speaks to this - https://www.irs.gov/taxtopics/tc701

    3.  So....  The proper way to do it is to sell your investment property and do a 1031 exchange.  You will take $500K in boot (remember this would normally be taxable).  But since you also qualify for the primary residence exemption this will become tax free when you report it.  The rest of the sale you'll put in the 1031.  Your reinvestment requirements should be to purchase around 1 mil (the net sale resulting from 1.63 minus closing costs minus the boot) using all $600K of net proceeds ($1 mil minus mortgage).  As long as you do this you will have maximized the 121 exemption and sheltered all of the remaining gain in the 1031.

    I've put together a couple videos on this exact subject.  I'll reach out PM to you.

    You have a wonderful opportunity to double dip here.  Congrats!!!

    The 1031 Investor5140 Reviews
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