Sale of Primary Residence With over $500K in Gain

9 Replies

Hi BP,

I have a question when you have over $500K in gain when selling your primary residence. Let's assume the big concern are the tax implications since the projected gain before the exclusion is $1.2M; see projected gain calculation below. The couple is MFJ and qualify for the $500K exclusion which leaves a net LTCG of $700K ($1.2M - $500K). With being in the highest tax bracket, the LTCG tax rate is 20% with a total tax of $140K ($700K X 20%).

The couple owns their current house free and clear and they're 70 years old and want to live in the new house they'll buy for the rest of their life. They don't want to do seller financing or a deferred sales trust.

The only option they will potentially consider is converting their primary to a rental for 1-2 years then selling the property as a 1031 exchange and buy another investment property in order to defer the $140K tax. Other than this approach (and no selling financing/deferred sales trust) is there any other approach to defer tax on the sale of your primary residence when your taxable gain is over $500K? Thanks in advance for the help!

Projected Gain Calc

  • Cost basis = $400K
  • Improvements = $100K
  • Adj Basis = $500K
  • Sell Price (after paying commissions, etc.) = $1.7M
  • Gain before exclusion = $1.2M

@Casey Murray , what a bad position to be in, so much money :) 

If they dont want to do 1031 after renting it out., the best I can think of is to invest in a Qualified Opportunity Zones Funds On 700k, they can defer their 85% capital gain up to 7 years, and not pay taxes on 15% capital gain. 

The reinvestment in the QOZ is completely tax free if held for more than 10 years. 

The good thing about this is, you dont have to reinvest entire 700k either, you can invest whatever amount you want. ( higher or lower). you can also use 700k and leverage to scale up the investment. 

Interested to see what others have to say. 

Originally posted by @Ashish Acharya :

@Casey Murray , what a bad position to be in, so much money :) 

If they dont want to do 1031 after renting it out., the best I can think of is to invest in a Qualified Opportunity Zones Funds On 700k, they can defer their 85% capital gain up to 7 years, and not pay taxes on 15% capital gain. 

The reinvestment in the QOZ is completely tax free if held for more than 10 years. 

The good thing about this is, you dont have to reinvest entire 700k either, you can invest whatever amount you want. ( higher or lower). you can also use 700k and leverage to scale up the investment. 

Interested to see what others have to say. 

 I was coming to suggest QOZs. I think you're a little off on the not having to reinvest the entire $700k. You have to invest all GAIN. You can take out your basis in cash (a full return on your initial investment) but the rest I believe needs to be invested int he QOZ property. But I haven't seen an example worked out yet with a primary home and exclusion being used in conjunction with it. 

The biggest issue with them is needing to "substantially improve" the property purchased in a zone. Meaning in 30 months after you buy it you must put in AS MUCH in renovations as the property cost. 

It can be a new build tho. 

If they could find  a perfect property in one of the zones they could tear down the house on it and build their dream retirement home? 

Do they have any dive bomb stocks they get sell this year to generate some large capital losses to help offset? 

Originally posted by @Natalie Kolodij :
Originally posted by @Ashish Acharya:

@Casey Murray , what a bad position to be in, so much money :) 

If they dont want to do 1031 after renting it out., the best I can think of is to invest in a Qualified Opportunity Zones Funds On 700k, they can defer their 85% capital gain up to 7 years, and not pay taxes on 15% capital gain. 

The reinvestment in the QOZ is completely tax free if held for more than 10 years. 

The good thing about this is, you dont have to reinvest entire 700k either, you can invest whatever amount you want. ( higher or lower). you can also use 700k and leverage to scale up the investment. 

Interested to see what others have to say. 

 I was coming to suggest QOZs. I think you're a little off on the not having to reinvest the entire $700k. You have to invest all GAIN. You can take out your basis in cash (a full return on your initial investment) but the rest I believe needs to be invested int he QOZ property. But I haven't seen an example worked out yet with a primary home and exclusion being used in conjunction with it. 

The biggest issue with them is needing to "substantially improve" the property purchased in a zone. Meaning in 30 months after you buy it you must put in AS MUCH in renovations as the property cost. 

It can be a new build tho. 

If they could find  a perfect property in one of the zones they could tear down the house on it and build their dream retirement home? 

You do not have to reinvest all the gain.  You can invest only the amount you want to defer the capital gain from your realized gain. 

Also, you invest in the fund, you personally do not have to go find the property. There are various companies that manage the fund and guarantee the compliance with the rules. 

You can do a Monetized Installment Sale on a primary residence. In this case, if the gain after exclusion is about $700,000, and assuming the sale pushes them into the top tax bracket (federal and state), or roughly 33% cap gains tax, the a MIS would save the seller about $118,000 in capital gains tax (deferred for 30 years). That's after considering that the net proceeds from the MIS would be less than 100% (93.5% is more like it).

When doing a MIS on a primary residence, the first think to consider is whether the proceeds will be used for a business purpose, because the monetization loan is considered a business loan (by the lender, and by the IRS). That enables the interest paid on the loan to be tax deductible. Sometimes I see sellers of primary residences putting the proceeds from their MIS loan into things that are unquestionably "investments," and there's no problem with that at all. 

If the seller uses the proceeds of the monetization loan for consumption purposes (including buying a primary residence, which in itself would not be considered a business purpose as it is personal property) then it's more difficult to see how one could justify the interest writeoff. 

However, there is a possible workaround. Under the right circumstances, I've seen sellers form a business entity (LLC) to buy their new primary residence, and then the LLC rents the property to the owner of the LLC. This would not be recommended for the everyday Mom and Pop seller but is something that can work for clients that are accustomed to investing, using business structures, and have the discipline to maintain the structure over time.

@Casey Murray

Ashish and Natalie both provided an excellent idea regarding investing in the QOZ.

I just wanted to touch base with you on some of the numbers in your post.
Your clients may be subject to more than $140K in tax.

They may also be subject to the 3.8% of Net Investment Income Tax.
Furthermore, since you are in CA, I assume your client is also in CA, and they may be subject to California state income taxes.

The seller may be able to offset it by using closing costs at closing to offset some of the gain.

The more the reason to consider the QOZ.

Updated almost 3 years ago

Oops - after careful thought. gain on the sale of a personal residence may not be subject to net investment income tax. State income tax should still apply.

There are open Qualified Opportunity Funds accepting investors right now. Not many but there are some. I know of Sikari Luxe which has 1 open fund, getting ready to open a 2nd one Sept 1 and plans for 3 more before end of Oct.