My husband and I bought 30 acres in 1994 (undeveloped) for $119K and in 1999 we built a home on the property for $200K. We have been approached to sell the property to a developer with 3 proposed scenarios:
1) sell 25 acres, we retain 5 acres and house - $1.2M
2) sell entire property - house will be demolished - $1.43M
3) Sell 25 acres to developer $1.2M, sell house and 5 acres separately $400K
Option 3 provides for the greatest cash proceeds, however I'm trying to determine what the tax implications are of each scenario. In which scenarios can we maximize the IRS Section 1031 and Section 121.
Scenario 1 - can only use 1031 like exchange - with limited cash retained (cost bases of the 25 acres) without paying capital gains
Scenario 2 & 3 - Can we utilize IRS Section 1031 and Section 121 for both scenarios. And in scenario 3, do both sales have to take place at the same time?
Any feedback is much appreciated.
I'm sure the 1031 exchange specialists will have some good advice. I will add this in advance -- you might consider a Monetized Installment Sale as an option for deferring gain on sale and giving you the option of getting cash at closing. You then can use that cash to invest in other real estate, as with an exchange, or you could use the funds to invest in something other than real estate. You would get 93.5% of the net sales proceeds in cash at closing, to invest however you like, and your capital gains tax would be deferred for 30 years.
@Christine B. , In general you can sell the land first and the home later and still apply sec 121 to the sale if the land was adjacent to the house and was used as part of the house and the house was sold within the two year period following the sale of the land - so that all is applied to the one sec 121 exclusion.
But I'm not sure that's the best course of action for you. Since your gain if you sold all would be roughly $1.3 mil ish you would only shelter $500K of that with your 121 exclusion. That would leave you with a taxable gain of $800K - no bueno!
But you're on the right track - you can separate those and use both 1031 and sec 121. You could sell the land as an investment piece of real estate and do a 1031 exchange on that portion as long as it is legally separatable from the house and lot the house is on like extra entitled lots or agricultural land surrounding the homestead. That will be tax deferred. And you can reinvest wherever you want into growth real estate or cash flow or whatever you wish.
The portion that is allocated to your primary residence you could sell and take the profit tax free. Spend that money wherever you want.
My guess is that the respective values of the land and house are such that you won't end up maximizing the tax free portion unless you've got an accountant with a sharp pencil. But you'll still get a significant chunk tax free and the remainder will all be tax deferred. and the deferred tax of $160K or so can all be utilized to bring you a higher return.
Very nice scenario