Sell rental to buy primary residence- tax question

Real Estate Agent · SF Bay Area · Member since 2016 · 25 posts · 10 votes

We are considering moving to a new area and would like to keep the home we currently live in as a rental. We would like to sell two smaller rentals we have to buy a new primary residence. We are looking for a primary resident with either an attached or detached in-law unit.

I’m concerned about capital gains and property taxes. The homes are all in CA and one has a good tax base because of prop 13 and how long we’ve had it. Are there any tax savings strategies we should explore to maximize tax savings?

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Maria D., It could be possible as @Brian G. said to sell those two smaller rentals and exchange into a multi family that you use partly for primary residence and partly as a rental. There's nothing inherently wrong with renting to your mom but the IRS will want it to be a transparent arms length arrangement. Detached or not does not matter as long as your accountant can make a delineation for the % of respective use.

The key to this would that the investment portion os the new property be enough to absorb both of the sales. You must take title to as much investment property as you sold. If the two rentals were sold for $400K and you wanted to purchase two unit property that was equal in size and worth $800K then that would work. But if the replacement property were only $600K and the rental portion was $200K it would not. You would be purchasing $200K less than what you sold and there would be a taxable event. So your plan is possible but you've got to watch the numbers.

What I'm most curious about is your decision to convert your current primary into a rental and sell the other two properties to invest. If you've lived in that property for at least 2 years then you could take the first $500K of profit tax free. This could be used to purchase the new property you're considering without having to think about 1031 or ratios or tax consequences. Primary residences rarely . make the best rentals. and tax free is always better than tax deferred.

There could always be a lot of factors that you haven't mentioned that make this a non-starter. But that's what jumped out at me first.

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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
7y
Originally posted by @Maria D.:

We are considering moving to a new area and would like to keep the home we currently live in as a rental. We would like to sell two smaller rentals we have to buy a new primary residence. We are looking for a primary resident with either an attached or detached in-law unit.
I’m concerned about capital gains and property taxes. The homes are all in CA and one has a good tax base because of prop 13 and how long we’ve had it. Are there any tax savings strategies we should explore to maximize tax savings?
Do you really need all the cash for the sale of the two rentals to buy a new property?
1) If you do: Sell the house. Pay the cap gain, and buy the house. No tax savings
2) If you do not:
a) Do 1031 exchange on the two property into one property and take some cash out to buy your residence. You can defer a portion of the cap gain this way. The cash out portion will be taxed.
b) Sell both properties. Invest the just gain in the Opportunity Zones and take the nontaxable basis of houses and buy a new property. This strategy avoids all federal taxation until 2026. You would pay tax on the 85% of cap gain that you deferred in the opportunity zones in 2026 if not sold earlier. Future appreciation is tax-free. CA does not conform with the Federal OPZ, so CA will tax your cap gain.
3) Sell you current residence and dont pay any taxes under section 121, if you qualify. Keep two small rentals.
This gives you talking points to your CPA. This is nowhere comprehensive as it needs to be.
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Brian G.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
7y
@Maria D. you might be able to 1031 proceeds from one/two rentals into a new primary if you purchase a multi unit (2-4) and rent out the units you are not living in or if you buy a home with a detached in law unit IF you rent that out.
@Dave Foster is a QI and the resident BP expert on 1031 exchanges if you have any questions. If your intent is not to rent out the detached in law unit then the 1031 won't help and I believe selling your current primary and using those funds is going to be the most tax efficient way to purchase your next primary. Definitely talk to a CPA to make sure you understand your options and choose the one that fits your overall goals/situation best.
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Maria D.
OP
Real Estate Agent · SF Bay Area · Member since 2016 · 25 posts · 10 votes
7y
@Brian Gerlach
The plan is my mom will live in the in law unit. I could rent it to her and live in the main house. That could possibly work. Does it have to be detached or just separate units? We’ve seen a few attached and rarely a detached.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Maria D., It could be possible as @Brian G. said to sell those two smaller rentals and exchange into a multi family that you use partly for primary residence and partly as a rental. There's nothing inherently wrong with renting to your mom but the IRS will want it to be a transparent arms length arrangement. Detached or not does not matter as long as your accountant can make a delineation for the % of respective use.
The key to this would that the investment portion os the new property be enough to absorb both of the sales. You must take title to as much investment property as you sold. If the two rentals were sold for $400K and you wanted to purchase two unit property that was equal in size and worth $800K then that would work. But if the replacement property were only $600K and the rental portion was $200K it would not. You would be purchasing $200K less than what you sold and there would be a taxable event. So your plan is possible but you've got to watch the numbers.
What I'm most curious about is your decision to convert your current primary into a rental and sell the other two properties to invest. If you've lived in that property for at least 2 years then you could take the first $500K of profit tax free. This could be used to purchase the new property you're considering without having to think about 1031 or ratios or tax consequences. Primary residences rarely . make the best rentals. and tax free is always better than tax deferred.
There could always be a lot of factors that you haven't mentioned that make this a non-starter. But that's what jumped out at me first.
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Maria D'Aura
Real Estate Agent · Livermore, CA · Member since 2016 · 173 posts · 74 votes
7y
Thanks for your reply. The reason for not selling our current primary is just in case we want to move back we want to be back in the same neighborhood and school boundaries.
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