Hesitant to sell Because of Tax Hit

16 Replies

I purchased a property @ $210,000 and after it's said and done, could probably sell for just under $400K w/$25K in fix up costs. 

The problem is, if it is sold in less than a year, I get hit hard with taxes.  I know if it was my primary residence (which it is not), I can get the $250K exemption - Tax Free!  Is there a middle ground?  Real Estate Exchange, but do I get my initial $210K investment back?  How long do I have to keep the property.

Hi @Ron Dulay  ,  Paying taxe is no fun.  Especially while there's ways to mitigate. @Josh E.  is right.  There's some good resources within BP to learn about 1031 exchanges.  You can also start your search right at qualified intermediary firms.  Most are happy to answer questions and guide you through the process.

Regarding the holding period, there is actually no statutory holding period to qualify for using a 1031 exchange.  The 1031 exchange is predicated on your "intent".  In order to qualify for 1031 treatment your intent must be to hold the property for what is called productive use.  Rental, running a business, long term incremental appreciation are all examples of productive use.  Purchasing a property with the primary intent of immediate resale does not qualify.  

@Bill Gulley  is correct in that the longer you have owned a property the easier it is for you to demonstrate that your intent was to hold it for productive use.  Conventional wisdom has said more than a year for a long time.  But there is no statutory magic in that number.

I would suggest you look at your normal business model.  Is your practice normally buy and hold but there is a reason for this sale?  Or is your normal business model fix n flip.  From what little you indicated in your post I would suspect fix n flip.  But it's worth a discussion with you tax advisor.  

It may be advisable to take the tax hit.  The reason the taxes are large is because the profit is large.

If the property potentially works as a rental, then sure go ahead and rent it out for a year or two, get a little income and then take advantage of the lower rates.

For a lot of people the tax rate difference is 10 to 13% between long-term and short-term capital gains.  In your example of 165K profit, the difference is 21.45 K at 13%.  That is just over 5% of the total value.  You can easily lose that selling at a less than ideal time or having to hold a property too long.  

However if you are only 2 or 3 months away from the 12 month period, it may make a lot of sense to adjust your closing date even if you have to carry the property for a few months.

How long have you owned it?     Perhaps you could put it on the market, then when you get an offer, set the closing date to cross the year threshold and offer the buyer an attractive lease term (w/ big DP/earnest money) at move-in?

It's not just real estate, the one year threshold has been well defined, to holding assets, it is generally accepted accounting practice which the IRS adheres to.

I have a similar issue right now, I may require that I finance it so as to defer the tax bite.

My understanding with a 1031 is that tax is deferred not avoided, when you sell the traded property that appreciates over the years you really get hit unless you keep that ball rolling, but someday, Uncle will get his due from a 1031.

I agree that a tenant in there will help justify your position.

I suggest you see your tax advisory first, list the options and select the best alternative. :) 

Originally posted by @Bill G.:

My understanding with a 1031 is that tax is deferred not avoided, when you sell the traded property that appreciates over the years you really get hit unless you keep that ball rolling, but someday, Uncle will get his due from a 1031. 

I thought I would  chime in here.  The statement above is not true.  Investors who continue to 1031 Exchange through out their lifetime and never sell and cash out will completely avoid the capital gain at the date of their death.  Their heirs will inherit the property and receive a step up in cost basis and the capital gain and depreciation recapture will completely disappear.  So, the 1031 Exchange is tax-deferred, but can also be tax-free if used properly.

Echo what @Bill Exeter  said.  The 1031 exchange has been used to provide great leaps of inter-generational wealth tax free for decades using the step up in basis as part of prudent estate planning.

Don't forget that's not just something for the next generation.  The 1031 can be used prior to that to shape your portfolio through the years into more active or more passively managed properties so that you can continue to make a return on the deferred tax dollars throughout your life.

And there's also the not quite tax free but still very tax-advantaged process of converting a 1031 property into your primary residence to take advantage of the provisions of sec 121.  

Uncle Sam may get his due.  But it doesn't have to be from you!

If you have the option set it up as a rental. You can defer 100% of your gain doing a 1031 exchange OR you can defer part of your gain and pull some cash out. You don't have to reinvest 100% of the proceeds in a 1031 but the money you do reinvest can be sheltered. If you have a large gain and want to pull out 50K you can defer taxes on the balance.

John Thedford, Real Estate Agent in FL (#BK3098153)
239-200-5600
Originally posted by @Bill Exeter :
Originally posted by @Bill G.:

My understanding with a 1031 is that tax is deferred not avoided, when you sell the traded property that appreciates over the years you really get hit unless you keep that ball rolling, but someday, Uncle will get his due from a 1031. 

I thought I would  chime in here.  The statement above is not true.  Investors who continue to 1031 Exchange through out their lifetime and never sell and cash out will completely avoid the capital gain at the date of their death.  Their heirs will inherit the property and receive a step up in cost basis and the capital gain and depreciation recapture will completely disappear.  So, the 1031 Exchange is tax-deferred, but can also be tax-free if used properly.

I do admire your 1031 knowledge, but what part of my statement is not true? I think I said "when you sell" and "unless you keep the ball rolling" meaning keep doing trades. My someday was to my selling it, eventually, wasn't speaking dying and estate taxes.

So, are you saying that if my estate exceeds the exemptions, property held from a 1031 won't be taxed in my estate? I'm not a tax guy, just an accountant type, seems to me it would be in that manner. The exception would come from proper planning, ahead of time.

Agreed, if you do some tax planning when setting up your business and exchanges, I can see the gain disappear in your estate. Seems it's not as "not true" as you stated Bill.  Had that statement been omitted, I wouldn't even be posting, and yield 1031 details to you. :)

Updated about 3 years ago

UPDATE Bill, to your next post, keep the ball rolling. Great idea. :)

@Bill Gulley  

You said "...but someday, Uncle will get his due from a 1031."  If you continually 1031 Exchange throughout your lifetime and never sell and cash out, Uncle Sam will never get his due.  You would get a full step up in cost basis and not pay any capital gain taxes or depreciation recapture taxes - ever.

@Bill G. - what Bill Exeter's last post did not explicitly state is that the 1031 happens repeatedly until death. The heirs inherit at stepped up basis, so the capital gains tax does not get paid. 


Estate "death" tax on the other hand will be assessed on the property's value at date of death. Might be nothing due to federal gov't if estate total value is below the exclusion amount in place for the year of death. 

@Bill Exeter  - I had to mention you separately because the way the BP mentions work, I could not mention two distinct Bills in the same post. 


@Joshua Dorkin  or @Brandon Turner  - another issue with mentions to add to the list of things to fix. 

Ladies and Gentlemen - I truly appreciate your comments and advice. As a background, historically, I've been a buy and rent out kinda guy, having 6 rentals SFR rentals right now. This last purchase was a too good a deal to pass up situation. It definitely needs fix up (as I'm in the middle of tiling the house now - LOL), but eventually it will be ready for the next step. Sound like at a minimum I should rent it out and pass the one year threshold. I'm OK with that. I am aware of the possibility of living at a property for two years as my primary residence to take advantage of the exemption. Lots of great info provided and I truly appreciate all of your wisdom.

Ron

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