Question on capital gains tax on multi-family sale

[Nav S.]

Hello :

I have a 2 family property near Boston, MA that I would like to sell.

I was using 1 unit as primary residence for just over 2 years before I had to relocate in mid 2016.

Currently both units are rented out and hence it is considered an investment property. I am in the 25% Fed tax bracket

Will there be capital gain taxes at both Fed and state level?

Any suggestions on how to lessen the tax impact?

Ideally I would like to use the profit to pay off some of my principal on current primary residence mortgage and use the rest for investing in a townhome that I can rent out...

Thank you for your inputs!

[Dave Toelkes]

If you sell before mid-2019, the tax treatment will be for the sale of an investment rental property and for the sale of a primary residence.  

Divide the sale proceeds in half and allocate one half of your capital gain due to appreciation to the sale of your former primary residence.  If this amount is less than or equal to the maximum §121 capital gains exclusion amount for your filing status, then there is no capital gains tax on your sale profit due to appreciation.  Since you converted your former primary residence to a rental, you will have depreciation recapture taxes on the depriation you took or should have taken whichever is greater.  If you delay the sale of your former residence unit until it has been more than 3 years since you vacated, your former primary residence becomes an investment rental and you no longer qualify for the §121 capital gains exclusion on the sale of a primary resdence.

You can use a 1031 exchange to defer capital gains taxes on the sale of the investment rental unit since you are planning to use some of the sale proceeds to invest in another rental.  

Consult a competent 1031 qualified inrtermediary about what clauses to write into your sales contract as well as the specific requirments for a successful tax deferred exchange.