How to avoid a tax hit?

Question

I own a condo in flagstaff and a house in Colorado.   I want to sell both to buy a house in New Mexico.    How do I do this without taking a huge tax hit?

Michael Plaks · Answer

@Dave Foster

I'm always grumpy. Consistency is key. :)

And since you stand by your response, I'll stand by mine. Nobody disagrees with your motto about the importance of taxes. Where we disagree is what comes first. I start with the problem, and you start with taxes.We have a tendency to get too excited about finding tax loopholes, often for the sake of tax loopholes. We often forget what problem we're trying to solve - or even identify the problem. Taxes are never the problem on its own. Taxes come into play when there're different ways to solve the problem: one is more tax-efficient than the other.

The original poster also happened to start with the wrong focus. Yes, he did ask about saving taxes on selling his properties. In that respect, MF is a valid option. But we need to look deeper: what is he really trying to accomplish? Move to another state! We don't even know if he needs to sell. And we jump into discussing taxes on the sale. It's like debating various surgery options before diagnosing the patient.

Money saved on taxes from selling his rental can only be rolled into an investment property, and he is looking for money to fund his residence. MF does not help to solve this problem, unless you're assuming that you can buy a duplex for the same price as a stand-alone house - a shaky assumption.

Michael Plaks · Answer

My mind is always blown when someone considers an idea "golden" merely for its tax consequences. As if living in a duplex next door to someone is the same as living in your own house. Or buying a house, renting it to some stranger for a year and only one year later moving in yourself somehow equates buying a new house today.

NEVER LET THE TAX TAIL WAG YOUR ENTIRE LIFE!

I'll write a separate response to the original question.

Dave Foster · Answer

@Michael Plaks, You're grumpy today :) Appreciate your thoughts. You presented some very good points for the op to consider.

I'm going to stand by my "golden" advice.  For this reason - I'm old school and I do believe the mantra that you make money when you buy.  But there's an equal corollary and that is "You keep your money by how you sell". Just because there's many options doesn't mean that you must leave tax planning off the table until you've decided what you want to do. Why would I ever want to explore all options with deliberately incomplete information??

Now making a decision simply on tax without considering everything else is equally foolish.  And I think that's what you're saying.  Otherwise we become the people who are so excited to get a tax refund every year.  Never realizing that we just gave the government an interest free loan for a year

The original question was how to sell an investment property and a primary residence and position those into a house in NM.  Seems to me like taxes should absolutely be a consideration at that point especially with the open ended options available.  The ability to sell those two houses and purchase a new investment property with the ability to live in part while generating tax free profits and tax deferred profits is one of the absolute best strategies out there for many investors.

You have to live someplace.  And by the way many people in America live in MF properties next to their neighbors by choice.   The 1031 pays for the property in part with deferred tax.  The tenants pay for the mortgage including principle return (both a tax write off and tax free return of your capital), you live close to your investment.  And when you once again sell you will again be able to take a portion of the profits tax free while continuing to defer the rest of the profits if you choose.  The downside.   You have to be willing to purchase a MF property.  Well a MF property or a property with two dwelling units on it.  Or a property with and ADU.  or a farm with a house on it. Or a property that is a caretakers house for something like a self storage or an assisted living facility.  There's actually Lot's of options.  Just depends on how the numbers pencil out.  But I didn't see any preclusions on that from the OP.

Michael Plaks · Answer

@Steve Cunningham

Only one thing seems non-debatable in your question: you're moving to NM. Everything else comes from assumptions, and each assumption can be challenged and have different solutions.

1. Do you want to buy a house in NM right away? Alternatives include renting short-term or long-term, building a house or even getting an RV. All depends on your life choices, not on taxes.

2. Assuming the answer is yes, do you have a way to buy that house without selling your existing properties? There're many ways to finance a homestead purchase, including the down payment.

3. If you determine that you must sell one or both properties to generate cash for down payment or to qualify for financing - then do you have to sell one or both? If one is enough - then which one is better to keep? Not from tax perspective, but from usefulness of the properties as an investment or a second home.

4. If you don't have to sell one of your properties - would you rather sell anyway or keep? Again, not a tax question.

5. Only now is time to consider taxes. Selling your current residence can be tax-free after 2 years of living there, as many people pointed out. Selling your rental property can NOT be tax free if you're planning to use the money to buy your personal residence.

6. Selling your rental can only be tax free if you use the proceeds for investment. Every single solution offered on this thread assumes investment: temporary leasing for 1 yr, 1031 exchange or multi-family. None of it helps your objective of using cash for an immediate purchase of your new home.

Dave Foster · Answer

@Steve Cunningham, For your primary it is original purchase price plus whatever capital improvements you made subtracted from the net sales price.  If you've lived in that property for at least 2 out of the 5 years prior to sale then you can take the first $250K (500K if married) of profit tax free.

For the investment property is is the original purchase price plus whatever improvements you made minus depreciation and subtracted from the net sales price.  If you want to avoid tax on this sale you would need to do a 1031 exchange and purchase another investment property.  Like @Matt Devincenzo said you can't just buy a primary with it.  His idea of purchasing a MF to be used for both primary and investment is golden!  And also @Dan Constantine and @Adam Gollatz gave you another great nugget on how to position those properties in the most tax advantaged way.

Dan Constantine · Answer

I sold my primary in Arvada in 2016.  Lived there 3.5 years.   At the time, I paid no tax because I lived there long enough.  You can make up to $250k if your single or $500k if your married without having to pay Uncle Sam.  The rental I think you’ll have no choice though.  But look at it this way, if you have to pay taxes then it means you made a profit and that’s a good thing.  If any of this has changed under Trump I am unaware.

Adam Gollatz · Answer

Im not sure how much these taxes are, but what I would look at doing is 1031 exchanging the rental into a rental property in NM. After a reasonable period, I think maybe 1 year, you can convert that NM rental into a primary residence. At which time you sell the colorado place and like dan said, if you lived there 2 of the last 5 years exclude capital gains and use that to pay off any debt on the NM primary residence.

Im not an accountant or tax advisor, so I would consult one of them.

Adam Gollatz · Answer

Depending on the uses of the properties it would fall under 1031 or 121. The condo and house in colorado, are they rentals or primary residences? The house in new mexico, is that going to be a rental or a primary residence?

Steve Cunningham · Answer

I am looking to purchase a single family residence in New Mexico.

I do now know what the taxes will be.  How do I find that out?

Matt Devincenzo · Answer

Are you interested in a SFR in NM or would a multi be a possibility? You can't use the 1031 on your primary in NM ....unless it was a multi and you 'allocated' the 1031 to the additional unit(s). There was a recent thread on here re: someone doing that on a purchase. That said are you sure your taxes will be that much? You might be assuming the worst, when in reality it's not really that much of a tax burden.

How to avoid a tax hit?

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