Selling real estate without capital gains or penalty

Member since 2019 · 1 post · 0 votes

I flip properties as a side job from my full time job and have been successful at it for about 9 years. I have always wanted to learn more about capital gains and the 1031 exchange program. I always keep my houses for two years so I am free from paying any capital gains but have a question about another scenario. I sold a house in June 2018 as I owned that home for 2 years and was my primary home up until last June. I have my current house that I fixed up which is my current primary residence and rented it out for about 9 months and have took it over afterwards as my primary residence. My two years of owning the home will be met this coming May. My question is can I sell this house this year without any penalty since I sold a house last year? This is a question my realtor and I have. Hoping someone can shed some light on this.

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Rhonda Blue

Real Estate Broker · East TN Loudon/Lenoir City/Tellico Village · Member since 2014 · 363 posts · 222 votes

I recommend the 1031 exchange process to investors all the time. AFter learning about this here on BP a few years ago I spoke with @Dave Foster and immediately knew that was the best option for deferring tax. I owned at the time 2 rental properties that I had originally bought as flips in St George UT and decided to rent for some extra cash flow. Then fast forward a few years when the market was high I sold and exchanged the funds into 4 other rental properties here in East TN.

There are restrictions for timing the sale and purchase but I knew I would have no problem designating a few new investment properties in 45 days.

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Brian Mahoney, This will sort of dovetail into a brief introduction of the 1031 exchange for you. First of all though you don't just get out of capital gains by owning a house for 2 years. You must have lived in if for 2 out of the 5 years prior to sale. That may be what you're saying. But you can only do that once every two years.
So The property you are living in now will not qualify for a couple of reasons. First you haven't lived in it for 2 years yet. Second, You're already done a sec 121 primary residence exclusion in the last two years. And third I think you're in a situation with that where you're not going to get the entire exemption when you sell anyway.
The reason is that if I"m reading it right you have converted a rental into your primary residence. When you do that a couple more requirements come into play in addition to having to live in it for two years and only doing the process once every two years. First you will have to recapture all depreciation from the time it was a rental. Second, you'll have to prorate the gain between the times of qualified use (as primary) and non-qualified use (as rental).
Since you only rented it for 9 months the depreciation probably wont kill you but you're only going to get around 2/3s of the gain tax free when you sell.
If you want to not pay any tax that's where the 1031 comes into play. But 1031 is only available for investment property. So if you wanted to do that on this house you would need to move back out and turn it into a rental again for a bit. The 1031 allows you to sell investment property and purchase replacement investment property without paying tax on the gain from the sale. It is a pretty powerful tool. But there's some requirements that you do have to pay attention to. The most important is that it is not DIY. You must have a qualified intermediary in place prior to the sale of any property you want to 1031. It's their job to document the exchange, handle the transfer of funds and consult with you to keep you on the straight and narrow.
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Jason Lee
Olive Branch, MS · Member since 2016 · 29 posts · 7 votes
7y
I have looked into the 1031 and basically what Dave said.
When the house sells you need someone in place like a CPA who specializes in 1031. They will hold the money, it can never come into your possession. You also have to play a crucial timing game as far as buying the next property.
It is all listed on the IRS website.
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Rhonda Blue
Real Estate Broker · East TN Loudon/Lenoir City/Tellico Village · Member since 2014 · 363 posts · 222 votes
7y
I recommend the 1031 exchange process to investors all the time. AFter learning about this here on BP a few years ago I spoke with @Dave Foster and immediately knew that was the best option for deferring tax. I owned at the time 2 rental properties that I had originally bought as flips in St George UT and decided to rent for some extra cash flow. Then fast forward a few years when the market was high I sold and exchanged the funds into 4 other rental properties here in East TN.
There are restrictions for timing the sale and purchase but I knew I would have no problem designating a few new investment properties in 45 days.
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Matthew Ryan
Developer · San Francisco, CA · Member since 2015 · 103 posts · 47 votes
7y
@Brian Mahoney - Opportunity Zones are also a newer but equally proficient way for deferring capital gains. Here are a few baseline rules:
1. Only the capital gain may be invested in an Opportunity Zone investment tax-free.
2. If you keep the investment for ten years, the capital gain at sale beyond the ten years is free of any tax. Five years and your basis (tax basis) are decreased by 10%, seven years = 15%.
3. Unlike 1031, you have 180 days from the day of the gain is recognized (you sell), to roll into an Opportunity zone project or "fund".
4. An OZ project must be "substantially improved" which limits it to development projects and very heavy value add. So if you're looking to invest actively and not passively, you would need to look for projects that meet this criterion. You have 30 months to complete the project renovation.
You can also get more info on the IRS website: https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions
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