Selling Rental, 1031 Exchange

6 Replies

Aloha everyone, I'm trying to figure out a capital gains tax question. I have a rental I'm selling to my tenant. I purchased in 2003, lived in it as primary til Oct 2007. My understanding is active duty military has 15 years to sell and not get taxed, but lived in it at least 2. For some reason I think I'm good. Plan to close on it in the next month 2 months. Just trying to figure out if I need to 1031 or can I just sell it regularly and not get taxed. I plan on using it for future rentals, but don't want to have a hard timeline set on me if I don't have to.Thanks

Originally posted by @Juan Sandoval :

Aloha everyone, I'm trying to figure out a capital gains tax question. I have a rental I'm selling to my tenant. I purchased in 2003, lived in it as primary til Oct 2007. My understanding is active duty military has 15 years to sell and not get taxed, but lived in it at least 2. For some reason I think I'm good. Plan to close on it in the next month 2 months. Just trying to figure out if I need to 1031 or can I just sell it regularly and not get taxed. I plan on using it for future rentals, but don't want to have a hard timeline set on me if I don't have to.Thanks

 Active duty military who are away from their property due to permanent change of station orders, can qualify for 2 of 15 instead of the standard 2 of 5 exclusion. If you closed by June 1, 2021, you would have had to live in it from June 2006 through June 2008. It is 2 of he last 15 years, so based on what you are saying, you would not qualify.

Also be aware that even if you are excluded from capital gains, you are still responsible for taxes on depreciation recapture.

@Joe Splitrock , that is what I was afraid of. Yes I understand the depreciation recapture. I should have sold it by Oct 2021 to have qualified. But that means if I 1031, I can differ that. Time to go shopping for a multi-family. Thank you

@Juan Sandoval

More to what Joe was saying yes,

Unless you had ‘permanent change of station orders’ making it impossible to live in your home as primary residence within the 5 years prior to selling, the 15 years doesn't seem to apply/ come into play.

The “15 years” only means an extension of the 5 year period prior to selling IF you couldn’t live there 2 of the years as primary within the 5 year original period, exercising this active military option THEN proceeding with a 1031 like- kind exchange.

As for active military application - military extension of the capital gains exclusion applies for active-duty military members who are away from their property due to permanent change of station orders to extend the 60-month period up to an additional 10 years.

This means that eligible military members may exclude their capital gains as long as they occupied the primary residence for two of the previous 15 years.

If you do proceed with the 1031 route, just keep in mind;

A brief summary of the 7 steps to 1031 exchange:

  1. Like- kind property; property being sold and the property being acquired must be similar
  2. 1031 exchanges are only applicable for investments or business properties, not personal properties (selling outright and not taking advantage of 1031 exchange in other words does not apply)
  3. Replacement property should be of equal or greater value
  4. No “boot” means no taxes, for a property to be completely tax free, the replacement property must not be of lesser value. The difference is the “boot” and subject to capital gains taxes
  5. Tax return and the name of the person appearing on the title of the property sold should match, as well as on the title of the new property acquired
  6. 45 day window of identification to identify up to three “like-kind” properties after closing on first one
  7. 180 day purchase window- 180 from closing on first property to close purchase on new, ‘like- kind; property



This may help too:

This is a link to the IRS “Armed Forces’ Tax Guide https://www.irs.gov/pub/irs-prior/p3--2019.pdf

But yes, two years as primary residence works, only applying to ‘active military’ if you needed to make it 15 years instead of 5 years as you were actively deployed or stationed away, making it impossible to live in the home for 2 years within the 5 ( let’s say ‘civilian’) year period and exercising the option to add 10 years.

Hope that helps = )

@Juan Sandoval , I've got a feeling your primary ship has sailed.  But primary exclusion rules aside, I think the biggest source of tax for you is going to be the depreciation recapture mentioned by @Joe Splitrock .  And that is not exempted in the primary residence sale. Almost 15 years of depreciation is more than half the structures value.  So a 1031 is still going to be your best answer to defer as much tax as possible.

@Juan Sandoval , the deadlines for 1031 exchanges mentioned by @Anna Laud tend to be the hardest part of the exchange process.  And most markets are hot now, so inventory tends to be low.  

A few words of advice:

  • if you do an exchange, try to lock up the property you want to buy before you sell (or very early in the process).  You can negotiate the contract before selling in a 1031.  Those 45 days in your identification window go by very, very fast. 
  • To "identify" a property, all you have to do is provide an address to your 1031 company.  You don't have to make an offer for this to count.  The property doesn't even have to be for sale! 
  • Don't tell sellers or their agents that you're doing a 1031 exchange. It might scare off those who don't understand them, and it will hand unnecessary leverage to those who do. 

Happy to answer any other questions you have.