Should i rent or sell or refinance a free and clear 2nd home

Modesto/Merced, California
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Should i rent or sell or refinance a free and clear 2nd home

Ethan Allen
Member since 2023 · 1 post · 2 votes

I sold my primary residence, cleared out my IRA and purchased a new home free and clear in California. I own free and clear a 2nd home in Modesto that my nephew is staying in.

So I just used up my 2 year no capital gain on my primary residence this year. Took all 500k out of my IRA, and am living on my social security income.

My 2nd home has gone up $200k in the 10 years i have owned it.  

It was just a home where i let my kids stay rent free until 2020 why my spouse died.  So it was never listed as an income property.

With my spouse's death, my son moved in with me and we sold the primary residence and  moved to the new place.

My daughter's son now lives in the Modesto house and pays all the expenses.

I want to eventually sell the Modesto house and buy something closer to my current home in Sacramento area and actually rent that to my nephew.

BUT (there is always a but) i may need to take money out of the Modesto house to pay the capital gains on closing my IRA to buy the new home free and clear.

At my age, keeping my primary home free and clear is an emotional necessity.  But I would like to know the tax implications on  1) selling it now,  2) renting it to my nephew at below market value and taking the rental deductions making it a business loss until i sell it.  3) just letting him stay there but pay ALL the expenses including property tax 4) doing a 1031 exchange for a $400k property near Sacramento.

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Edward Zachary Samperio
New to Real Estate · San Antonio, TX · Member since 2021 · 110 posts · 58 votes
3y

Based on the information you provided, here are the tax implications for each of the scenarios you mentioned:

  1. If you sell the Modesto house now, you would likely owe capital gains taxes on the $200,000 increase in value since you purchased it. The exact amount of taxes you would owe would depend on your income tax bracket and other factors. It's worth noting that if you've owned the property for more than one year, the capital gains tax rate is generally lower than the rate for short-term gains.
  2. If you rent the Modesto house to your nephew below market value, you could still take deductions for expenses related to the property, such as property taxes and repairs. However, if you consistently report a rental loss year after year, the IRS may view it as a hobby rather than a business, and you may not be able to claim the losses.
  3. If your nephew pays all the expenses, including property taxes, but does not pay rent, you cannot claim any rental deductions or losses. The property would still be considered a personal residence for tax purposes.
  4. If you do a 1031 exchange for a $400,000 property near Sacramento, you could defer paying capital gains taxes on the sale of the Modesto house. However, to qualify for a 1031 exchange, the property must be used for business or investment purposes. If your nephew continues to live in the property and it is not rented out at market value, it may be difficult to argue that it is being used for investment purposes.

It's important to note that tax laws can be complex and vary depending on individual circumstances, so it's always a good idea to consult with a tax professional or financial advisor before making any decisions.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    3y

    @Ethan Allen, It sounds like you have lived in this new primary for two years.  And that means that it has also been two years since your last tax free sale.  You should be able to sell it now and again take the primary residence exemption.  However you will only get $250K tax free since your spouse has passed.

    You can do anything you want with that property now via 2 and 3.  There may be some impact on the deductibility of expenses and taking depreciation.

    The one thing you cannot do is to do a 1031 on that property right now because it is your primary residence.  And 1031 exchanges are only for investment property.  If you rent to your nephew for a while you could then 1031 exchange it since it is being used as investment.  And you would also qualify for the primary residence exemption.  So you would get up to $250K tax free and defer the rest in a 1031 exchange.

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  • Edward Zachary Samperio
    New to Real Estate · San Antonio, TX · Member since 2021 · 110 posts · 58 votes
    3y

    Based on the information you provided, here are the tax implications for each of the scenarios you mentioned:

    1. If you sell the Modesto house now, you would likely owe capital gains taxes on the $200,000 increase in value since you purchased it. The exact amount of taxes you would owe would depend on your income tax bracket and other factors. It's worth noting that if you've owned the property for more than one year, the capital gains tax rate is generally lower than the rate for short-term gains.
    2. If you rent the Modesto house to your nephew below market value, you could still take deductions for expenses related to the property, such as property taxes and repairs. However, if you consistently report a rental loss year after year, the IRS may view it as a hobby rather than a business, and you may not be able to claim the losses.
    3. If your nephew pays all the expenses, including property taxes, but does not pay rent, you cannot claim any rental deductions or losses. The property would still be considered a personal residence for tax purposes.
    4. If you do a 1031 exchange for a $400,000 property near Sacramento, you could defer paying capital gains taxes on the sale of the Modesto house. However, to qualify for a 1031 exchange, the property must be used for business or investment purposes. If your nephew continues to live in the property and it is not rented out at market value, it may be difficult to argue that it is being used for investment purposes.

    It's important to note that tax laws can be complex and vary depending on individual circumstances, so it's always a good idea to consult with a tax professional or financial advisor before making any decisions.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    3y

    Nice synopsis @Edward Zachary Samperio!

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