What to do with my equity?

Question

Hi, I have $1mm in equity in my residence. I owe about $600K and pay about $3400/mo in mortgage. Taxes are low since I have lived here for over 8 years. If I move to a like house, cost is about $1.2mm and then my property taxes are roughly $10K/year (compare to $4K/yr now). BUT I would only be fianancing $300K or so (closing costs etc.) Since I can take up to $500K on captial gains (I am married) I would be paying taxes on the balance? Not sure of how this works. Any advice would be appreciated. Any suggestions on what to do with my equity would also be appreciated.

Thanks,

Bryan Casteel · Answer

First of all, congratulations on an excellent investment.  If your home does sell for $1.6MM, then making $1MM in 8 years ain't so bad I'd say.

You do not need to buy a "like" house for any tax reasons.  The only way you will get to take advantage of a 1031 exchange is to move out of your house and rent it for 4 years then sell it.  If you need to sell it now, you can take the first $500K tax free and the pay our Uncle Sam on the rest.  There may be some creative loopholes available to you, but you will need to get that accountant or lawyer to explain.  I am sure you are not the only one in CA dealing with huge capital gains on your primary residence right now.

As for finding an accountant or lawyer, I would look for the tallest building downtown.  Go to the top floor of that building and find the most important person you can find and ask them.  That is tongue-and-cheek of course, but what I am saying is to ask around.  The last thing you want to do is just open the Yellow Pages to find someone - get some recommendations and then interview the candidates.  You are dealing with a lot of money, so it is worth the effort.

Jason Barnett · Answer

Ahh rats... I forget sometimes that most people don't live in an investment property like I do.  And let me tell you, I'm about ready to move out of mine for good!

N/A N/A · Answer

Hi--this is great advice.

Just in case you feel like dispensing more advice, here's my scoop:

1.  We built our primary residence about 8 years ago for $500K...we did the bare bones, so we re-fi'ed several times making improvements over the 8 years, ending up with the 600K balance.

2.  In order to buy like property(like in both SFR and quality) we'd have to spend a min of $1.2mm.

3.  I agree I need a good accountant...but they are so hard to find.  Most want to plug numbers into a computer and get you out the door in 2 seconds.  SO if you have any recommendation here in SF I would appreciate.

Again, thanks for the advice!

Bryan Casteel · Answer

Hold the phone.  You can't 1031 your primary residence.  1031 is for investment vehicles only.

mscoilcraft, you need a good accountant and probably a creative financial planner or lawyer (and we all now know you can afford these professionals).

How much did you pay for the home when you purchased it?  When did you purchase it?  Your capital gains is the difference between your sale price and your purchase price.  You are allowed up to $500K in capital gains (for married couples) in your primary residence.  You will pay taxes on any capital gains over $500K.  In order for the property to qualify, you must have used it as your primary residence for at least 2 of the last 5 years.

The reason you need an accountant is to handle the tax consequences and to do the hard core number crunching on your options.  You need the financial planner or the lawyer to discuss how you can use trusts (personal trusts and land trusts) and other estate planning tools to protect your wealth.

How you use the equity is a personal choice, but one easy solution is to move it into a new house and then get a line of credit from the bank.  You can use the line of credit as your personal bank for other investments as they arise.  When you are not using the line of credit, you are not paying any interest.  Also the LOC has the added benefit of hiding your equity from someone that might want to sue you for your equity because to the outside world it looks like you have a loan against the property whether you have accessed the line or not.

Jason Barnett · Answer

Total tax liability is going to depend on how much you actually sell it for.  Yes you would be paying taxes on the balance if you just sold.  However, you can do a 1031 exchange where you sell the residence, put the proceeds into a custodian's account and buy a different residence with those proceeds.  The key thing here is that you've got to purchase a like kind of property (i.e. single family residence).  The "quality" of the two properties don't matter.  However, if you pay less for the new property then you can be liable for the difference.

I have never stepped down in a 1031 exchange so this is purely conjecture... but I would guess that your tax liability would be something like this:

$Sale price of your current home
- $Sale price of home you buy through 1031
---------------------------------------------------
  $Boot

$Boot
- $500K
------------------
  $Taxable gain