I'm brand new to real estate sales, but have been asked by an in-law for advice on selling her home (for better or worse!). We will definitely eventually engage a professional, but I wanted to check with you knowledgable folks first to make sure I have a solid strategy going into that discussion.
The house was bought >10 years ago for 800k and is now worth between 2-3.3m per Redfin and Zillow. Her husband passed away, but she has not been remarried. The mortgage is nearly paid off. If I understand it correctly, she will have to pay taxes on the selling price minus the purchase price, cost of any improvements, and 500k federal exemption.
Are there any other strategies which could be employed to reduce the tax burden? From what I've researched thus far the only option would be to rent out the house and then later do a 1031 exchange. Unfortunately, I know she is not interested in renting the place out.
Another option that I've thought of is that my wife and I could buy the house from her if she were to supply the financing (as we cannot afford a mortgage on that house now) and then we could sell the house after living in it for two years and also get the 500k federal tax deduction. However, it is my understanding that she can't sell the house at a 500k discount to us as that would be considered a gift, so this would only work if the house gained 500k over the two years we inhabited it (which is wishful thinking!). Given that housing prices are hard to estimate until they hit the market, is there a way to come up with a reasonably conservative price which would not be considered a gift?
Some other research that I did indicated that if there are multiple owners which have all occupied the house for some 2 of the last 5 years, then they all can benefit from the 500k deduction (if they are couples, 250k for individuals). Would it be possible for my in-law to sell 500k of the house to my spouse and I, use that 500k to buy herself a new cheaper house to move into, and then we all sell the original house together 2 years later for a total of 1m tax exemption?
Thanks in advance for your help. Perhaps I'm making this more complex than necessary but given the potential tax burden I'm trying to evaluate all possibilities - especially since the house is in an ideal location for my spouse and I to live there for a couple years.
I don’t know about your proposed strategies, but if she is no longer married she won’t be filing jointly, so her exemption is $250k.
Your strategy of buying a tenant in common interest is interesting. Of course using the new numbers she would have to sell you a $500K TIC which would then create a $250K gain to her anyway and do nothing to alleviate the remaining gain at the end any way. I don't know how the Service would like a scenario like that.
The most common scenario we get with situations like this is that if she can be patient, then she moves out of that house for a year and rents it. She doesn't specifically have to have a full time rentor - it could be rented as a vacation rental. And in fact you could rent from her as long as it was arms length with a lease and real rent payments etc.
It is now an investment property and she could then sell and do a 1031 exchange. The first act of the 1031 is for her to take 250K in boot. This would normally be taxable but since she qualifies for the sec 121 exemption it comes to her tax free and she reinvests the other $2.5 mil into passive long term 1031 compliant investments and that is her retirement fund.
End game - you get a place to live for a year or two. She gets $250K tax free. She defers tax on the remainder and ends up with $2.5 mil in investments cranking out cash flow the rest of her life. That's a pretty good end game - if she can be patient.
I see that I was wrong on the Sec 121 exemption for the deceased spouse; upon further research, it looks like there is still some benefit, but that its a bit more complicated to calculate.
The 1031 exchange sounds more interesting than I realized. You mention that she would reinvest the $2.5mil into passive long term 1031 compliant investments - does that mean another real estate property? Or are there other, more hands off 1031 compliant investments that she could invest in? While she may be willing to be my landlord for a year, I do not think she would want to manage a property after the sale of the house. Certainly not for a long period of time.
@Andrew A. , To be compliant with 1031 the investor must sell an an interest in investment real estate and purchase an interest in investment real estate. For this reason stocks, REITS, partnerships etc do not work for 1031. In these you are purchasing ownership of a company or entity that owns real estate and not the real estate itself.
However there is a hierarchy of real estate ownership that complies with 1031 treatment and runs the range from active to passive.
Turn key properties offer a definite move toward passive and are 1031 compliant.
The truly passive alternatives that still comply with 1031 and offer that management free cash flow are NNN properties, Delaware Statutory Trusts, and Tenant In Common properties. These are typically viewed as long term management free vehicles that provide national corporate tenant guaranteed income with no hassle.
I assumed that she wasn't really interested in developing a portfolio or even being a landlord. This is common for folks at a certain point whether or not they were real estate investors prior to that. There comes a time to slow down and exit. And when an investor does this using 1031 they want to continue to get the benefit of deferred tax and additional income indefinitely. That's really what those last three are good for. And we've placed hundreds of clients into all of them depending on what their needs/priorities were.
By the way there is actually an after end game as well that may appeal to her. If she follows the plan, defers the tax and enjoys the income for the rest of her life when she dies her heirs will get a step up in basis so at her death the tax goes away. And the heirs can do what they want with the property. Many of our clients really love the idea of passing something that powerful along to the next gen.
Thanks for the insight @Dave Foster ! I was unaware of of the passive 1031 investments - its a good option that I'll definitely be looking more into.