@Jon Holdman, thank you for so generously taking the time to answer in detail. I most certainly will consult a CPA. I wanted to see If I could come up with some rough figures to see if this is even a viable option vs. holding the property and doing a 1031 exchange. By the way, a local realtor told me that for 1031 exchanges the owner is no longer allowed to ever live in the exchanged property as his/her primary residence (even after renting for a couple years). She said this was a rule that had been recently added; do you know if this is true?
Thanks for your help regarding calculating the gains. I was not able to easily find out what my father had paid for the house so I went to my County Clerk Recorder's office where they instructed me to look for the documentary transfer tax paid on the house. (I'm assuming this is the information that would be provided in the HUD-1 you mentioned.) They then gave me a conversion formula of 1.10 in tax per 1,000 paid for the house. Using this formula I calculated my father bought the home for 68,500, which I understand would be my basis.It's now worth about 940,000.
As for improvements, the house has new roofing, bay windows, marble entryway, new fence, new pool heater, sprinkler system, satellite dish, security system, and I’ll put in new flooring. Besides the flooring those are the improvements I know were added by my father. The realtor told me that I could estimate about 50k in improvements and take pictures as proof of them if I don’t have documentation; is this correct? I suppose if I cannot add improvements to my basis this will be a factor to consider in whether to do a 1031 exchange since there won’t be any capital gains to pay in that scenario, correct?
Thanks for your explanation of depreciation. Would straight line depreciation be applicable in this scenario? So, if I understand you correctly, it is taken as a yearly deduction when the property is used as a rental, but then whatever was deducted as depreciation during the property’s rental years is subtracted from the basis when the property is sold? In other words, I’ll end up paying capital gains on whatever cumulative amount I take as deductions over the years the property is rented .
I didn’t understand what you said here: “Further, the amount of gain up the the deprecation taken or allowed, whichever is greater, is subject to a recapture tax. That's at your ordinary tax rate, but is currently capped at 25%.”I did some Googling but am not clear on what the recapture tax is, exactly. Could you please point me to a good explanation?
I don’t believe I’ll end up with losses when I rent since the house is paid in full (is that what you mean – that the rental income may not cover the mortgage? Or are there other losses to anticipate?)
I realize, too, from reading the IRS publication, that another option I have would be to rent the property for less than three years and then sell it. That would still allow me the homeowner’s exclusion, since I would’ve lived in the property for two years before renting it, which would be two out of the five years prior to the sale of the property. Is that right?
I’m not sure why the realtor I spoke with quoted me a capital gains rate of 20%.
Finally, would there be any state taxes to be paid as well?
Thank you so much; this is all incredibly helpful as I get a rough idea of whether I’d do better selling now or doing an exchange in a couple years. I’d lose my father’s very low property tax basis if/when I did the exchange. Also, I don’t know much about real estate and when doing an analysis of the profit on the house as a rental property saw that it was less than the average stock market returns.That, too, was some very rough figuring, so I’ll have to research those topics as well.
Thanks so much for your help!
-Dina
