ThreeRiversREI
01-12-2007, 10:52 PM
The full article is available here. (http://www.inman.com/hstory.aspx?ID=61172)
Someone was commenting the other day about the difficulties in downsizing. When this article came across Inman News, it reminded me and I wanted to relay part of it.
Further back, someone ELSE was asking about buying a primary residence KNOWING that they'd be moving before 2 years were up, but wondering if they'd be able to take advantage of any portion of the Section 121 exemption.
The quotes below seem to give guidance to both situations. As always, consult your attorney, CPA, tax adviser, etc. to verify the details for your specific situation. Batteries not included.
HOW TO QUALIFY FOR THIS TAX BREAK. Whether you own and live in a house, condo, cooperative apartment or other type of principal residence, you can qualify for Uncle Sam's most generous tax exemption. To be eligible, you must have owned and occupied your primary dwelling at least 24 of the last 60 months before its sale.
Involves a bunch of moving, but would allow you to exclude a good chuck on the built up capital gain in a rental property that you have little to no basis in due to 1031 Starker Exchanges and depreciation. Move in for 2 years, sell, and *poof* $250k per owner.
Single home sellers can qualify for up to $250,000 tax-free profits. A married couple filing a joint tax return can qualify for up to $500,000 tax-free capital gains if both spouses meet the occupancy test even if only one spouse's name is on the title.
The method of holding title doesn't matter. Title can even be held in a revocable living trust, as millions do, to avoid probate.
However, if there are two co-owners not married to each other, then both names must be on the title for each to qualify. Military and Foreign Service members have special generous rules allowing the 24-month occupancy period as far back as 15 years before the home sale.
Not sure how that would apply to holding title in a partnership, LLC, or corporate name. But the property could always be transfered for $1 for the sole purpose or retitling it appropriately if necessary.
If you bought your principal residence as recently as 24 months ago, and occupied it since then, you meet the ownership and occupancy test. The 24-month residency need not be continuous. Brief temporary absences, such as for a 30-day vacation, count as occupancy time.
However, if you acquired your home in an Internal Revenue Code 1031 tax-deferred exchange as a rental property, and later converted it to your principal residence, for such sales after Oct. 22, 2004, you must own the property at least 60 months (24 of which it must be your principal residence).
Here's the first "gotcha". If you did a Starker Exchange, you have to hang onto it for a full 5 years. Likely not a problem in liquidating property you've held for a long time, but a potential problem when combined with the below.
The IRS says principal-residence indicators -- if you own more than one residence -- are (1) place of employment; (2) principal abode for the taxpayer's family members; (3) address on taxpayer's federal and state income tax returns; (4) location of taxpayer's banks; (5) automobile and driver's license registrations; (6) voting location; and (7) civic affiliations, such as taxpayer's religious organizations and other membership groups.
That's "gotcha" number 2. If you DO move from rental to rental, making them your "primary residence" for 24 months so you can get the exemption, make sure you actually MOVE and don't try to pull one over on the IRS. They are not amused. Besides the IRS can, and has, found out the truth and hauled taxpayers into court for back taxes, penalties & interest!
ADJOINING VACANT LAND SALE CAN ALSO QUALIFY. Another little-known benefit of IRC 121 allows the sale of a vacant lot adjoining the principal residence to qualify for this tax exemption. However, the adjacent principal residence must be sold within 24 months before or after the lot sale.
Won't apply in many cases, but when it does, it's nice. The article doesn't make it clear if the vacant land has its own $250k exemption, or if it shares the exemption with the residence itself.
PARTIAL EXEMPTION IF YOU DON'T MEET THE 24-MONTH OCCUPANCY TEST. If you occupied your principal residence less than the required 24 months, but the reason for your home sale is (1) change of employment site meeting the moving-cost tax-deduction rules; (2) health reasons; or (3) unforeseen circumstances, you can qualify for a partial exemption based on the number of occupancy months.
The "unforeseen circumstances" rules are still evolving. The IRS allows these acceptable reasons: (1) divorce or legal separation; (2) death in the immediate family; (3) unemployment; (4) decreased income with the homeowner unable to pay the mortgage and basic living expenses; (5) multiple births from the same pregnancy; (6) damage to the home from a natural or manmade disaster or terrorism; and (7) condemnation, seizure or other involuntary conversion of the property.
If you qualify for a partial exemption, and you occupied the principal residence 18 of the 24 required months, for example, then you qualify for 75 percent of the $250,000 or $500,000 exemption.
Here's the answer to the second situation mentioned at the top. I'm no tax attorney, but my read here is that if you buy a house knowing that your job or other "unforseen circumstance" will trigger a move in less than 24 months on a specific date, don't chance it. On the other hand, if it's only a possibility and there is ALSO a possibility of remaining for a minimum of 24 months you should be okay.
TWO WAYS TO AVOID TAX ON MORE THAN $250,000 OR $500,000 HOME-SALE CAPITAL GAIN. If you will have a principal-residence-sale capital gain exceeding the $250,000 or $500,000 exemptions, there are two ways to avoid tax:
1. The first method is to convert your home into a rental property. Then it qualifies for an Internal Revenue Code 1031 tax-deferred exchange for another rental or business property of equal or greater cost and equity.
Most tax advisers suggest renting your former principal residence at least six to 12 months before exchanging it. IRC 1031(a)(3), known as a "Starker exchange," then allows selling the property, having the sale proceeds held by a qualified intermediary third-party beyond your constructive receipt, designating the replacement property within 45 days, and completing the acquisition within 180 days after the old property's sale.
2. The second method, allowed by IRS Revenue Procedure 2005-14 effective Jan. 27, 2005, allows use of both IRC 121 and IRC 1031 in a single property sale. This slightly complicated ruling is retroactive to tax years for which the statute of limitations has not expired.
Gain is first excluded under IRC 121 up to $250,000 or $500,000, and the remaining gain then can qualify for an IRC 1031 tax-deferred exchange. An example of this procedure applies where the principal residence was converted to a rental and then the property is "down traded" for another rental property after claiming the IRC 121 exemption.
And the second half of this answer is likely the key to downsizing without paying huge capital gains tax bills. Convert a rental to your primary residence, use Section 121 to exclude a BIG chunk of capital gains taxes, and Starker Exchange any remaining gain into a smaller rental. Catch being "gotcha" number one above, that the new property would have to be held for a full five years minimum before this could be done again. But with at least 3 properties being moved into/sold/exchanged in rotation, you'd be working on a 6 year cycle and should be okay.
Maybe it's time to start exchanging those apartment buildings for mansions and retire in luxury?
Someone was commenting the other day about the difficulties in downsizing. When this article came across Inman News, it reminded me and I wanted to relay part of it.
Further back, someone ELSE was asking about buying a primary residence KNOWING that they'd be moving before 2 years were up, but wondering if they'd be able to take advantage of any portion of the Section 121 exemption.
The quotes below seem to give guidance to both situations. As always, consult your attorney, CPA, tax adviser, etc. to verify the details for your specific situation. Batteries not included.
HOW TO QUALIFY FOR THIS TAX BREAK. Whether you own and live in a house, condo, cooperative apartment or other type of principal residence, you can qualify for Uncle Sam's most generous tax exemption. To be eligible, you must have owned and occupied your primary dwelling at least 24 of the last 60 months before its sale.
Involves a bunch of moving, but would allow you to exclude a good chuck on the built up capital gain in a rental property that you have little to no basis in due to 1031 Starker Exchanges and depreciation. Move in for 2 years, sell, and *poof* $250k per owner.
Single home sellers can qualify for up to $250,000 tax-free profits. A married couple filing a joint tax return can qualify for up to $500,000 tax-free capital gains if both spouses meet the occupancy test even if only one spouse's name is on the title.
The method of holding title doesn't matter. Title can even be held in a revocable living trust, as millions do, to avoid probate.
However, if there are two co-owners not married to each other, then both names must be on the title for each to qualify. Military and Foreign Service members have special generous rules allowing the 24-month occupancy period as far back as 15 years before the home sale.
Not sure how that would apply to holding title in a partnership, LLC, or corporate name. But the property could always be transfered for $1 for the sole purpose or retitling it appropriately if necessary.
If you bought your principal residence as recently as 24 months ago, and occupied it since then, you meet the ownership and occupancy test. The 24-month residency need not be continuous. Brief temporary absences, such as for a 30-day vacation, count as occupancy time.
However, if you acquired your home in an Internal Revenue Code 1031 tax-deferred exchange as a rental property, and later converted it to your principal residence, for such sales after Oct. 22, 2004, you must own the property at least 60 months (24 of which it must be your principal residence).
Here's the first "gotcha". If you did a Starker Exchange, you have to hang onto it for a full 5 years. Likely not a problem in liquidating property you've held for a long time, but a potential problem when combined with the below.
The IRS says principal-residence indicators -- if you own more than one residence -- are (1) place of employment; (2) principal abode for the taxpayer's family members; (3) address on taxpayer's federal and state income tax returns; (4) location of taxpayer's banks; (5) automobile and driver's license registrations; (6) voting location; and (7) civic affiliations, such as taxpayer's religious organizations and other membership groups.
That's "gotcha" number 2. If you DO move from rental to rental, making them your "primary residence" for 24 months so you can get the exemption, make sure you actually MOVE and don't try to pull one over on the IRS. They are not amused. Besides the IRS can, and has, found out the truth and hauled taxpayers into court for back taxes, penalties & interest!
ADJOINING VACANT LAND SALE CAN ALSO QUALIFY. Another little-known benefit of IRC 121 allows the sale of a vacant lot adjoining the principal residence to qualify for this tax exemption. However, the adjacent principal residence must be sold within 24 months before or after the lot sale.
Won't apply in many cases, but when it does, it's nice. The article doesn't make it clear if the vacant land has its own $250k exemption, or if it shares the exemption with the residence itself.
PARTIAL EXEMPTION IF YOU DON'T MEET THE 24-MONTH OCCUPANCY TEST. If you occupied your principal residence less than the required 24 months, but the reason for your home sale is (1) change of employment site meeting the moving-cost tax-deduction rules; (2) health reasons; or (3) unforeseen circumstances, you can qualify for a partial exemption based on the number of occupancy months.
The "unforeseen circumstances" rules are still evolving. The IRS allows these acceptable reasons: (1) divorce or legal separation; (2) death in the immediate family; (3) unemployment; (4) decreased income with the homeowner unable to pay the mortgage and basic living expenses; (5) multiple births from the same pregnancy; (6) damage to the home from a natural or manmade disaster or terrorism; and (7) condemnation, seizure or other involuntary conversion of the property.
If you qualify for a partial exemption, and you occupied the principal residence 18 of the 24 required months, for example, then you qualify for 75 percent of the $250,000 or $500,000 exemption.
Here's the answer to the second situation mentioned at the top. I'm no tax attorney, but my read here is that if you buy a house knowing that your job or other "unforseen circumstance" will trigger a move in less than 24 months on a specific date, don't chance it. On the other hand, if it's only a possibility and there is ALSO a possibility of remaining for a minimum of 24 months you should be okay.
TWO WAYS TO AVOID TAX ON MORE THAN $250,000 OR $500,000 HOME-SALE CAPITAL GAIN. If you will have a principal-residence-sale capital gain exceeding the $250,000 or $500,000 exemptions, there are two ways to avoid tax:
1. The first method is to convert your home into a rental property. Then it qualifies for an Internal Revenue Code 1031 tax-deferred exchange for another rental or business property of equal or greater cost and equity.
Most tax advisers suggest renting your former principal residence at least six to 12 months before exchanging it. IRC 1031(a)(3), known as a "Starker exchange," then allows selling the property, having the sale proceeds held by a qualified intermediary third-party beyond your constructive receipt, designating the replacement property within 45 days, and completing the acquisition within 180 days after the old property's sale.
2. The second method, allowed by IRS Revenue Procedure 2005-14 effective Jan. 27, 2005, allows use of both IRC 121 and IRC 1031 in a single property sale. This slightly complicated ruling is retroactive to tax years for which the statute of limitations has not expired.
Gain is first excluded under IRC 121 up to $250,000 or $500,000, and the remaining gain then can qualify for an IRC 1031 tax-deferred exchange. An example of this procedure applies where the principal residence was converted to a rental and then the property is "down traded" for another rental property after claiming the IRC 121 exemption.
And the second half of this answer is likely the key to downsizing without paying huge capital gains tax bills. Convert a rental to your primary residence, use Section 121 to exclude a BIG chunk of capital gains taxes, and Starker Exchange any remaining gain into a smaller rental. Catch being "gotcha" number one above, that the new property would have to be held for a full five years minimum before this could be done again. But with at least 3 properties being moved into/sold/exchanged in rotation, you'd be working on a 6 year cycle and should be okay.
Maybe it's time to start exchanging those apartment buildings for mansions and retire in luxury?