1031 Exchange or 121 exclusion or both??

Question

Ladies and Gentlemen,

I have a landlord friend of mine that lives down the street and is getting roasted due to covid 19 and a tenant who hasn't paid rent since February 2020. He lives in a small 4plex apartment in which he occupies one unit with his wife and kids.(3bed house) He's been living there for 4years and planing on selling and buying a SFH. 3 units will be delivered vacant at the close of escrow. Tenant who hasn't paid will be the only to stay in the property. Can he use a 1031 exchange? Or 121 exclusion?? Or maybe both?? Let's say he rather just sell his property out flat how much tax is he looking to pay when he sells? 20% or is it 25%?? I understand if you file single your exempted up to 250k tax free on your primary residence but I'm not sure if this applies to multi unit property.
Sadly he’s looking into walking away from this business due to the rules and regulations California has set during covid 19. What other way can he be able to sell and buy his home? Any help would be appreciated. He’s an older dude paying the mortgage on his own. I’ve been trying to help landlords around my area in any way possible. Specially when tenants are taking advantage of this situation

Ricardo P. · Answer

@Dave Foster great 411! I took a screen shot and text it over to him. From what I know he’s been living there 4years this up coming December so he has not yet had the property for 5years. He’s an older guy and it seems as if he’s just tired of all the drama. I think he might be leaning towards just taking the hit of the great California tax and move on. I don’t blame him. So do you think we are looking at a 20-25% tax hit or more towards like 30%?

Cara Lonsdale · Answer

Hey @Dave Foster, can you clarify....IF the Seller uses his primary residence exclusion, is he limited to 25% of the total amount of the sales price to account for his 1/4 usage as a primary residence, or can he take ALL of the $250K/$500K if married, as the whole property being his primary residence?

Dave Foster · Answer

@Cara Lonsdale, Good catch.  I jumped ahead on valuations.  He would get to take all of the profit associated with the primary residence portion tax free up to the 250/500K limits.  So if the total gain as $400K and his primary was 25% he would get to take $100K tax free

Dave Foster · Answer

@Ricardo P. In CA his tax could approach 30%.  His accountant can verify because the tax will be at a blended and different rate for depreciation recapture, fed cap gains, state cap gains/income, possible ACA surcharge.  But in industry terms - sell in CA and you pay a truck load of taxes!

But the good news is that your friend can use any part of the statute they qualify for.  Have they lived in the unit for two out of the last five years?  Then they qualify for the primary residence exemption.  Are the other units used for investment?  Then they can 1031 exchange that part.

So they will be able to take some cash from the table tax free and tax defer the rest of the gain and depreciation recapture.  It's actually a great opportunity for them - especially if it gets rid of that free loader.

What he can't do is use the 1031 exchange initially to purchase his next primary residence.  However, with a little bit of patience he could buy as part of his 1031 a really nice investment property that he converts to his primary in a year or two.  He just can't move in immediately.

He could also use his tax free money to buy a temporary primary residence and then move out and into the new primary he purchased with his 1031 dollars.  So many options if you have a little time and patiencs:)

1031 Exchange or 121 exclusion or both??

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