Question on personal residence capital gains tax

10 Replies

So, I was talking to a friend who is looking to help her father sell his house. He's owned it for many many years and it is in a nice area. The plan is that he will buy a smaller condo for himself and probably another rental out of the proceeds. 

He'll have more than $250k in profit from the sale (it will actually be closer to $400k) so there will be capital gains tax due.  My suggestion was that they take out a loan against the house to buy either the new condo or the rental, which would then bring the proceeds of the house sale down below $250k and avoid the cap gains tax.  My friend thought I was being totally outrageous and suggesting something fraudulent! I'm pretty sure that's not the case (and it certainly wasn't my intention) but it did raise a specter of doubt in my mind... so, I am appealing to the CPAs and tax folk here. Is there anything wrong with the scenario I proposed? Thanks!

A loan does not change the gain. The gain is  basically calculated by taking the selling price, and from that subtracting closing costs, purchase price and capital improvements. 

Why not convert the primary residence FIRST...then do a sale. There are tax experts that can help this be achieved if the main worry is taxes. Other option is to get married before they sell:)  Find a good CPA to help make a decision.

John Thedford, Real Estate Agent in FL (#BK3098153)
239-200-5600

@Jean Bolger  

You didn't mention if he was married, but as @John Thedford eludes to, if married the first $500k in profit is tax exempt.

Even so, pocketing $250k tax free is way better than any other option. Remember the long term capital gains tax is only 15%. Which is still significantly lower than what most people pay in income tax.

I would not consider converting to an investment property, as you will lose the $250K tax free gain. Even with a 1031 exchange, you are only postponing the tax. You will eventually have to pay if the property or new like-kind properties are liquidated.

I would take the $250k tax free and pay out the small 15% on the remaining profit (as long as he does not make more than $400k in total income for the year, for higher earners cap gain is 20%). Also, you can always use that new chunk of cash and max out IRA or other tax sheltered account contributions to limit your taxes even further.

Jesse Hinaman, Lender in CA (#NMLS 1411475)
(916) 934-3457

@John Thedford is right.  He could convert the house to a rental for up to 3 years and not lose the benefit of the primary residence exclusion while at the same time positioning him to also use the 1031 to protect the excess profit.

The rules for the primary residence are that he has lived in the property for 2 out of the previous 5 years.  So if he moved out now converting the property to a rental (maybe tap equity to buy his next residence) he could sell the property as late as 3 years from now.  He would do a 1031 exchange and take $250K in boot.  Normally the boot would be taxable but in this case it is covered by the primary exclusion.  Meanwhile the rest of the sale is covered under the 1031 exchange.  He will have to recapture depreciation but that is all.  The remainder of the transaction would be either tax free or tax deferred.

@Dave Foster where do you think I learned this valuable information::)


For anyone seeking a great 1031 guy...Dave is the man! I sat in a 1031 class he gave at the Ft Myers board. He know his stuff.

John Thedford, Real Estate Agent in FL (#BK3098153)
239-200-5600

If he is not married and wants to try avoiding the taxes on profit, does he qualify for a solo 401k? If I remember correctly, he can stick $50k into that to defer, plus max an IRA for $5.5k/$6.5k. He could use those funds to fund a purchase of the investment property.

Just spit-balling. I think no matter what, he should be happy to be in a situation that requires paying taxes ;)

Originally posted by @Bryan O. :

If he is not married and wants to try avoiding the taxes on profit, does he qualify for a solo 401k? If I remember correctly, he can stick $50k into that to defer, plus max an IRA for $5.5k/$6.5k. He could use those funds to fund a purchase of the investment property.

Just spit-balling. I think no matter what, he should be happy to be in a situation that requires paying taxes ;)

Bryan, gains from the sale of a personal residence can not be contributed to a Solo 401k plan, you can only use earned self-employment income for the purposes of calculating your contributions into qualified plan. 

Dmitriy Fomichenko, Broker
(949) 228-9393

@Bryan O.

What @Dmitriy Fomichenko notes is correct.  However, we see situations where someone has earned income from self employment and also has a large capital gain.  The gain, in and of itself cannot be use for plan contributions, but you can live off that and then have the potential to make as much of a contribution to the plan as possible from your self-employment income.  Not sure if this fits the scenario described, but wanted to add to the conversation.

Originally posted by @Jean Bolger :

gotcha! (duh, profit does not equal gain) 

Not sure what you are trying to say here.  In my view of the world profit is realized gain. Could you have really meant to say:   profit does not equal equity?

@Jesse Hinaman

Just to clarify.  For most taxpayers, the maximum long term capital gain tax rate is 15%, but for high income taxpayers, the maximum rate is 20%.  

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