Author Topic: 1031 Exchange Question  (Read 2074 times)

dragonwalker

  • 5 O'Clock Shadow
  • *
  • Posts: 93
1031 Exchange Question
« on: December 14, 2016, 11:18:12 PM »
My mother owns 2 properties, her primary residence in southern CA and a residential property she rents out in northern CA. She has owned the rental property in northern CA for about 6 years and has rented continuously throughout. My mother is looking to move out of her primary residence and rent it out and buy another home that is smaller. She happens to have a close friend who has agreed to sell her home to my mother for $610,000.

My mother brought up the idea of perhaps conducting a 1031 exchange. I believe that she would be able to "sell" her home in northern CA, current Zillow value of $710,000 and exchange it for her friend's home. However, assuming the homes sell and are purchased for the price mentioned, my mother would have to pay long term capital gains tax of about $100,000 for the difference in value between the new and old home.

However, my mother would not be permitted to move into her friend's newly acquired home for 2 years because of 1031 exchange rules. My mother would have to rent out the new property for 2 years before being able to move in.

My mother has also envisioned having at least 3 residential properties, 1 to live and 2 to generate rental income. Could she in theory "sell" the home in northern CA, exchange for her friend's home, and then seek and acquire yet another home so that she does not have to pay capital gains tax at all.

She is looking to do this in order to find homes near her in southern CA so that they would be easier to maintain. Originally when she bought the northern CA home she thought she might move to northern CA to retire but she has since changed her mind and is looking to stay in southern CA.

Could anyone here tell me anything that I might have gotten wrong or other additional considerations? Thank you. 

jwright

  • Bristles
  • ***
  • Posts: 269
Re: 1031 Exchange Question
« Reply #1 on: December 15, 2016, 09:27:50 AM »
A few things to unpack.

First, you can only exchange business or investment properties.    So she can not relinquish her current principal residence.  She can relinquish the rental property and exchange it into a new investment property.  If the replacement property is less than the relinquished property, she is going to end up with taxable boot that she would have to pay tax on; the closing costs and debt relief also figure into the boot calculation.  She can use the funds to purchase two replacement properties to use up all of the proceeds.  The 45 day indentification timeline and 180 day closin timeline start when the property is relinquished so she needs to have the second property lined up pretty quickly.

There is no set rule on the amount of time the property is used for investment to qualify.  The government has proposed in the past a one year period, so your mom probably wants to rent out the new property for at least a year before moving in.  Obviously, the longer that time the easier it would be to quantify investment intent. 

waltworks

  • Magnum Stache
  • ******
  • Posts: 3431
Re: 1031 Exchange Question
« Reply #2 on: December 15, 2016, 09:56:21 AM »
My understanding is that if you take up residence in a rental that you've been depreciating (and remove it from service as a rental) you will owe the back depreciation (and maybe capital gains taxes?) at that time.

I could be wrong about this, but I'm pretty sure the "move into the rental and avoid a ton of taxes" scheme doesn't actually work.

She should talk to her accountant before pulling the trigger on this plan.

-W

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1513
  • Age: 60
  • Location: Redmond, WA
    • Evergreen Small Business
Re: 1031 Exchange Question
« Reply #3 on: December 15, 2016, 03:32:17 PM »
A few things to unpack.

First, you can only exchange business or investment properties.    So she can not relinquish her current principal residence.  She can relinquish the rental property and exchange it into a new investment property.  If the replacement property is less than the relinquished property, she is going to end up with taxable boot that she would have to pay tax on; the closing costs and debt relief also figure into the boot calculation.  She can use the funds to purchase two replacement properties to use up all of the proceeds.  The 45 day indentification timeline and 180 day closin timeline start when the property is relinquished so she needs to have the second property lined up pretty quickly.

There is no set rule on the amount of time the property is used for investment to qualify.  The government has proposed in the past a one year period, so your mom probably wants to rent out the new property for at least a year before moving in.  Obviously, the longer that time the easier it would be to quantify investment intent.

I agree with JWright. FWIW, around the watercooler, you regularly hear people use a "two year" window.

NoNonsenseLandlord

  • Bristles
  • ***
  • Posts: 396
  • Age: 60
  • Location: Eagan, MN
    • No Nonsense Landlord
Re: 1031 Exchange Question
« Reply #4 on: December 24, 2016, 05:58:12 PM »
She gets a capital gains exclusion when she sells her principal residence.  No need for a 1031.  There is no requirement that you buy another either.

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5145
Re: 1031 Exchange Question
« Reply #5 on: December 24, 2016, 08:16:43 PM »
She gets a capital gains exclusion when she sells her principal residence.  No need for a 1031.  There is no requirement that you buy another either.

A single person gets a $250,000 exclusion.  She is in an expensive part of Southern California, so her capital gain likely far exceeds $250,000.  Furthermore, under the old capital gains rules, you could roll the gain on your residence into a more expensive replacement (move up).  I did that.  With the appreciation on my current house and the rolled gain, I would be writing checks to Uncles Sam and Jerry totalling near $200,000.  Not going to happen.  In her shoes, I would do the same thing - rent out my house and move into the smaller house after a reasonable period elapsed.

She can sell her $710,000 home and buy two replacement properties for more than $710,000 and owe no tax on capital gains or recaptured depreciation at that time as long as she follows the 1031 rules.  The basis moves to the new properties.
« Last Edit: December 24, 2016, 08:22:05 PM by Another Reader »

NoNonsenseLandlord

  • Bristles
  • ***
  • Posts: 396
  • Age: 60
  • Location: Eagan, MN
    • No Nonsense Landlord
Re: 1031 Exchange Question
« Reply #6 on: December 25, 2016, 05:16:27 AM »
She gets a capital gains exclusion when she sells her principal residence.  No need for a 1031.  There is no requirement that you buy another either.

A single person gets a $250,000 exclusion.  She is in an expensive part of Southern California, so her capital gain likely far exceeds $250,000.  Furthermore, under the old capital gains rules, you could roll the gain on your residence into a more expensive replacement (move up).  I did that.  With the appreciation on my current house and the rolled gain, I would be writing checks to Uncles Sam and Jerry totalling near $200,000.  Not going to happen.  In her shoes, I would do the same thing - rent out my house and move into the smaller house after a reasonable period elapsed.

She can sell her $710,000 home and buy two replacement properties for more than $710,000 and owe no tax on capital gains or recaptured depreciation at that time as long as she follows the 1031 rules.  The basis moves to the new properties.

She could sell the property to a fiend, and the friend to her, and both take a $250K exclusion.  Both continue to live in the same houses.

Then, two years later, sell them back to each other for no gain.  Then, since they both lived in the house for the past two years, get another $250K exclusion.

GreenEggs

  • Pencil Stache
  • ****
  • Posts: 801
  • Location: Here & There
Re: 1031 Exchange Question
« Reply #7 on: December 25, 2016, 06:15:07 AM »
1031's seem to be the the IRS way to encourage us be be landlords....

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5145
Re: 1031 Exchange Question
« Reply #8 on: December 25, 2016, 06:46:33 AM »
She gets a capital gains exclusion when she sells her principal residence.  No need for a 1031.  There is no requirement that you buy another either.

A single person gets a $250,000 exclusion.  She is in an expensive part of Southern California, so her capital gain likely far exceeds $250,000.  Furthermore, under the old capital gains rules, you could roll the gain on your residence into a more expensive replacement (move up).  I did that.  With the appreciation on my current house and the rolled gain, I would be writing checks to Uncles Sam and Jerry totalling near $200,000.  Not going to happen.  In her shoes, I would do the same thing - rent out my house and move into the smaller house after a reasonable period elapsed.

She can sell her $710,000 home and buy two replacement properties for more than $710,000 and owe no tax on capital gains or recaptured depreciation at that time as long as she follows the 1031 rules.  The basis moves to the new properties.

She could sell the property to a fiend, and the friend to her, and both take a $250K exclusion.  Both continue to live in the same houses.

Then, two years later, sell them back to each other for no gain.  Then, since they both lived in the house for the past two years, get another $250K exclusion.

A new basis would be set by the transfer.  There would have to be a gain to get the second exclusion.

In California, there are huge property tax ramifications of transfers.  California is an acquisition value state.  Property taxes are based on the value when property is purchased.  There are lots of 1975 values still out there.  A transfer often means more than a 500 percent increase in property taxes.