Author Topic: Taxes on real estate  (Read 2515 times)

effigy98

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Taxes on real estate
« on: November 30, 2016, 04:40:11 PM »
I have been blessed and cursed to live in the Seattle area. I have two dilemmas.

1. My primary residence is about to hit over 500k profit which as I understand for married people you have to pay tax on anything over that when you sell. I was not planning on selling for a least a decade but learning this maybe I should. Is there a way around this? Should I sell and "upgrade" to another to update my cost basis of equal value basically to avoid huge taxes later?

2. I purchased a condo during the real estate crash for a family member who rents from me. However, fair market rents have tippled from what they are paying and they cannot afford to pay me more so I cannot claim as a rental any longer. As I understand it, I need to reclassify as a secondary residence. The problem is when I go to sell I am hit with another HUGE tax bill of 20%. Not sure what to do here. How are others avoiding tax or do you just pay it?

okobrien

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Re: Taxes on real estate
« Reply #1 on: November 30, 2016, 05:07:21 PM »
As far as the first dilemma, don't forget that you subtract any associated costs of buying or selling the house from your profit (as well as capital improvement)  Based on the fact that you are making more than half a million profit , I am sure your transaction costs are quite large. 

On the topic of transaction costs, if you are trading one $850,000 house for another, you are looking at some serious transaction costs that may outweigh taxes on another couple hundred thousand in profit.

Another thing to think about is that Seattle has been on a tear for a long time now. I'm not sure I would make a major life decision based on the expectation that major appreciation would continue.
« Last Edit: November 30, 2016, 05:14:15 PM by okobrien »

fishnfool

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Re: Taxes on real estate
« Reply #2 on: November 30, 2016, 05:22:43 PM »
After you sell your primary home, move into the condo for a few years then sell it to avoid the taxes.

okobrien

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Re: Taxes on real estate
« Reply #3 on: December 01, 2016, 08:03:51 AM »
As I understand it, I need to reclassify as a secondary residence. The problem is when I go to sell I am hit with another HUGE tax bill of 20%. Not sure what to do here. How are others avoiding tax or do you just pay it?
Now that I go back and re-read your second question, it looks like you weren't expecting to pay capital gains tax when the condo was classified as a rental?  Maybe I misunderstand what you wrote, but whether the condo is considered a rental or a secondary home you will need to pay tax on the appreciation when you sell. (Unless you do a 1031 exchange) 
Also, are taking your annual depreciation on the rental?  Even if you aren't taking the deduction the IRS is going to ask for a depreciation recapture when you sell the property.

jwright

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Re: Taxes on real estate
« Reply #4 on: December 01, 2016, 09:15:00 AM »
First question - you would pay capital gains on the amount of gain (after all closing costs and improvement costs are added to your basis) over $500,000.  But that would still only be taxed at the favorable capital gain rates (which may change soon).  I would look at the real costs of moving and buying a new place before committing to selling based on possible future tax consequences.

Second question - I'm not following.  Is your relative not paying anything at all?  You should be able to calculate and possibly deduct the losses on this property on your tax return.  If you cannot deduct them now because your income is too high, you will be able to deduct the losses when you sell the property and that would help offset the appreciation gain.  I'm not sure why you need to classify this as a second residence as long as they are paying rent based on what was at the time an arm's length transaction for $x/month. 

effigy98

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Re: Taxes on real estate
« Reply #5 on: December 01, 2016, 11:28:14 AM »
According to the information I can find, renting at below fair market counts as personal use and cannot be counted as a rental.

Examples Here:
https://www.irs.gov/publications/p527/ch05.html

jwright

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Re: Taxes on real estate
« Reply #6 on: December 02, 2016, 08:29:32 AM »
According to the information I can find, renting at below fair market counts as personal use and cannot be counted as a rental.

Examples Here:
https://www.irs.gov/publications/p527/ch05.html

What is your agreement with your relative?  Was the current rent a fair price at the time they moved in and the market has changed?  Do they have a lease?   How far under market are they?

arebelspy

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Re: Taxes on real estate
« Reply #7 on: December 04, 2016, 06:59:11 AM »
After you sell your primary home, move into the condo for a few years then sell it to avoid the taxes.

They got rid of this rule years ago (2010?).  It's now prorated based on the time you lived in it.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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okobrien

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Re: Taxes on real estate
« Reply #8 on: December 04, 2016, 07:24:04 AM »
After you sell your primary home, move into the condo for a few years then sell it to avoid the taxes.

They got rid of this rule years ago (2010?).  It's now prorated based on the time you lived in it.
I thought it was based on the last 5 years,  meaning if you owned the rental for decades, move in, and five years later sell it, you can claim 100% primary exempt.

arebelspy

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Re: Taxes on real estate
« Reply #9 on: December 04, 2016, 07:45:29 AM »
After you sell your primary home, move into the condo for a few years then sell it to avoid the taxes.

They got rid of this rule years ago (2010?).  It's now prorated based on the time you lived in it.
I thought it was based on the last 5 years,  meaning if you owned the rental for decades, move in, and five years later sell it, you can claim 100% primary exempt.

Not that I'm aware of.  Have any citation for that?

I think it's all years since this went into effect, in 2009.  So if OP moved in for two years (say, 2017 and 2018), they could exclude 2/x years (where x = total since 2009 that they owned it.. they said "bought in the crash" so I'd assume some time in 09-11, so probably 7-9 years), and the other (x-2)/9 would be not-excluded.

As always, check with a professional, but this is my understanding.  Feel free to correct me if you have another opinion.  :)

EDIT: If it was owned longer than that, as a rental, all those years count as well, obviously... was just focusing on bought since then.  See bacchi's post right below this one, and links, for better info.  :)
« Last Edit: December 04, 2016, 04:46:04 PM by arebelspy »
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

bacchi

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Re: Taxes on real estate
« Reply #10 on: December 04, 2016, 10:21:01 AM »
Yes, it's prorated. Only the gains when the property is in use as a primary residence count for the cap gains exclusion. For simplicity, it's PR-use/total-years-owned, as ARS wrote.

See "nonqualified use" here: https://www.law.cornell.edu/uscode/text/26/121

The second section here explains it in less legalese: https://www.kitces.com/blog/limits-to-converting-rental-property-into-a-primary-residence-to-plan-for-irc-section-121-capital-gains-exclusion/

« Last Edit: December 04, 2016, 10:23:13 AM by bacchi »

okobrien

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Re: Taxes on real estate
« Reply #11 on: December 04, 2016, 10:35:58 AM »


Yes, it's prorated. Only the gains when the property is in use as a primary residence count for the cap gains exclusion. For simplicity, it's PR-use/total-years-owned, as ARS wrote.

See "nonqualified use" here: https://www.law.cornell.edu/uscode/text/26/121

The second section here explains it in less legalese: https://www.kitces.com/blog/limits-to-converting-rental-property-into-a-primary-residence-to-plan-for-irc-section-121-capital-gains-exclusion/

Thanks for this explanation.  Mike Kitcies has some great in depth stuff.  Based on discussions with my accountant, I misunderstood the exclusion rules.  I assume he understands it correctly and I misunderstood his explanation.

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fishnfool

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Re: Taxes on real estate
« Reply #12 on: December 04, 2016, 06:18:08 PM »
Thanks for sharing the kitcies link, lots of good info. ;)