What would you do with this case?

18 Replies | Los Angeles County, California

Hi guys,

I'm trying to help a relative here and I need your insight.

She bought her house for 70k in the 70s, now the area is well sought after in SM and it's worth north of 3.2MIL....it was never rented and now that she wants to sell...we found out that there will be a 32% capital gain tax...after deducting the 250k (single) + 70k (original price)+ 90k (renovations)...she will have to pay a little above 900k in taxes and wont be able to get a house for 2.5MIL that she liked. 

We were told that she is not qualified for the 1031 exchange, since the house was never rented before. Other than that she does have other rental properties...what would you guys in this case?

Thank you!!!

@Ouman You   Wow. That is some appreciation! A 1031 is out of the question because it is not an investment property. The best option would be to consider a Monetized Installment Sale. This is a way to structure your sale so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This sales structure is pretty common in CA where property values have appreciated as you've described.

@Ouman You If the property was her primary residence, yes, it will not qualify for 1031 exchange treatment. If she hasn't lived in it as her primary, if she has held the property for appreciation, she may qualify for 1031 exchange treatment. To complete a 1031 exchange, you don't necessarily have to rent the property, you could hold the property for appreciation. Is the property reported as her primary on her tax return?

@Shiloh Lundahl - if she isn't currently living in the property, yes, she could move back into the property and live there for 24 out of 60 months to qualify for the 121 primary exclusion. But there is a limit to how much you can exclude from ordinary income. It looks like she will be well beyond that amount. If she's single, she can deduct 250k from ordinary income and 500k if she is married. Looks like her gain well exceeds that. If she is living in the property right now, she could move out, rent the property for 24 months, put the property up for sale and sell within that 5th year so that she can qualify for the exclusion and anything above that amount could qualify for 1031 exchange treatment.

Originally posted by @Thomas Rutkowski :

@Ouman You   Wow. That is some appreciation! A 1031 is out of the question because it is not an investment property. The best option would be to consider a Monetized Installment Sale. This is a way to structure your sale so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This sales structure is pretty common in CA where property values have appreciated as you've described.

Thank you for your suggestion. 30 years seems long, knowing that she wants to buy a new property.

Originally posted by @Ouman You :
Originally posted by @Thomas Rutkowski:

@Ouman You   Wow. That is some appreciation! A 1031 is out of the question because it is not an investment property. The best option would be to consider a Monetized Installment Sale. This is a way to structure your sale so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This sales structure is pretty common in CA where property values have appreciated as you've described.

Thank you for your suggestion. 30 years seems long, knowing that she wants to buy a new property.

 I think you misunderstood my post. The seller walks away with cash in hand and a 30-year tax-deferral. That cash is used to buy the next property.

Originally posted by @Lauren Speidel :

@Shiloh Lundahl - if she isn't currently living in the property, yes, she could move back into the property and live there for 24 out of 60 months to qualify for the 121 primary exclusion. But there is a limit to how much you can exclude from ordinary income. It looks like she will be well beyond that amount. If she's single, she can deduct 250k from ordinary income and 500k if she is married. Looks like her gain well exceeds that. If she is living in the property right now, she could move out, rent the property for 24 months, put the property up for sale and sell within that 5th year so that she can qualify for the exclusion and anything above that amount could qualify for 1031 exchange treatment.

 Thank you. I dont know if I understand you fully. 

So after she rents it for 1 year, what's the amount that will be excluded from the capital gains? And does she have to buy an income property once she sells her house or can she buy a house where she can live in?

Originally posted by @Lauren Speidel :

@Ouman You If the property was her primary residence, yes, it will not qualify for 1031 exchange treatment. If she hasn't lived in it as her primary, if she has held the property for appreciation, she may qualify for 1031 exchange treatment. To complete a 1031 exchange, you don't necessarily have to rent the property, you could hold the property for appreciation. Is the property reported as her primary on her tax return?

 Yes it is her primary residence. 

@Ouman You Thanks for clarification. So it sounds like she may qualify for the 121 primary exclusion but again, her gain exceeds that. She could move out, rent the property for 24 months, and sell within that fifth year. Then she may qualify for the 121 exclusion and also a 1031 exchange. Feel free to reach out should you have more questions about this type of transaction.

Originally posted by @Thomas Rutkowski :
Originally posted by @Ouman You:
Originally posted by @Thomas Rutkowski:

@Ouman You   Wow. That is some appreciation! A 1031 is out of the question because it is not an investment property. The best option would be to consider a Monetized Installment Sale. This is a way to structure your sale so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This sales structure is pretty common in CA where property values have appreciated as you've described.

Thank you for your suggestion. 30 years seems long, knowing that she wants to buy a new property.

 I think you misunderstood my post. The seller walks away with cash in hand and a 30-year tax-deferral. That cash is used to buy the next property.

 Thank you. But I need you to simplify for me is this is all new to me.

Sell the house let's say for 3.5 mil. By the new home for 2.5 mil...how do we go about tax deferral ? How much will be paid in taxes and when is it due?

Because to my understanding once the house is sold it's due for 20% federal tax and 12% state of that fiscal year. 

Thank you, 

@Ouman You    Wow. That is some appreciation! A 1031 is out of the question because it is not an investment property. The best option would be to consider a Monetized Installment Sale. This is a way to structure your sale so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This sales structure is pretty common in CA where property values have appreciated as you've described.

Thank you for your suggestion. 30 years seems long, knowing that she wants to buy a new property.

 I think you misunderstood my post. The seller walks away with cash in hand and a 30-year tax-deferral. That cash is used to buy the next property.

 Thank you. But I need you to simplify for me is this is all new to me.

Sell the house let's say for 3.5 mil. By the new home for 2.5 mil...how do we go about tax deferral ? How much will be paid in taxes and when is it due?

Because to my understanding once the house is sold it's due for 20% federal tax and 12% state of that fiscal year. 

Thank you, 

The important takeaway is exactly what I stated: Its a way for the seller to get cash at closing and defer the taxes for 30 years. If you want to see the nitty gritty details, I just shared them in this post for another member with a large capital gains tax problem...

https://www.biggerpockets.com/forums/51/topics/569...

I’m curious what part of the country is this?

CA by any chance?

This situation makes me think how so many people believed the lie the US govt told people that their home is their biggest asset 

Well ah yes if you want to sell and live in a lower priced house. 

Originally posted by @Thomas Rutkowski :

@Ouman You   Wow. That is some appreciation! A 1031 is out of the question because it is not an investment property. The best option would be to consider a Monetized Installment Sale. This is a way to structure your sale so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This sales structure is pretty common in CA where property values have appreciated as you've described.

Thank you for your suggestion. 30 years seems long, knowing that she wants to buy a new property.

 I think you misunderstood my post. The seller walks away with cash in hand and a 30-year tax-deferral. That cash is used to buy the next property.

 Thank you. But I need you to simplify for me is this is all new to me.

Sell the house let's say for 3.5 mil. By the new home for 2.5 mil...how do we go about tax deferral ? How much will be paid in taxes and when is it due?

Because to my understanding once the house is sold it's due for 20% federal tax and 12% state of that fiscal year. 

Thank you, 

The important takeaway is exactly what I stated: Its a way for the seller to get cash at closing and defer the taxes for 30 years. If you want to see the nitty gritty details, I just shared them in this post for another member with a large capital gains tax problem...

https://www.biggerpockets.com/forums/51/topics/569...

 I visited the link. And I will be lying to you if I understood most of the stuff you covered. 

Bu thank you for your help. 

Originally posted by @Michael Plante :

I’m curious what part of the country is this?

CA by any chance?

This situation makes me think how so many people believed the lie the US govt told people that their home is their biggest asset 

Well ah yes if you want to sell and live in a lower priced house. 

 Yes CA....state tax 12% federalism 20%.

Originally posted by @Lauren Speidel :

@Ouman You Thanks for clarification. So it sounds like she may qualify for the 121 primary exclusion but again, her gain exceeds that. She could move out, rent the property for 24 months, and sell within that fifth year. Then she may qualify for the 121 exclusion and also a 1031 exchange. Feel free to reach out should you have more questions about this type of transaction.

 If she rents it for a year and qualifies for 1031 exchange can she buy another home or she has to buy an income property ?

@Ouman You if she rents it and then does a 1031 exchange the replacement property will also have to be an investment property. A 1031 is for "like-kind" property so investment for investment. I suppose theoretically she could hold the replacement as an investment property for a period of time and then make it her residence, but thats a question for the QIs and CPAs. 

Doesn't really sound like she wants to rent out her place for 2 years, rent or buy another place for 4 years, exchange into the new place and rent/hold it for 2 years then move into that new place. But maybe she does?

She could keep the old place, cash out refinance it and use all that equity to buy a new place and another rental while keeping it as a rental. 

I'd look at as many options as possible before taking a $900k tax hit.