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Old 05-13-2015, 04:46 PM
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Red face 1031 Exchange - to move in or not to move in?

Hello! I'm looking for your help to quantify my alternatives as an unmarried landlord holding a rental property.

Here's the history: I purchased a duplex @ $65K in 1996 and lived in half, then moved and rented both units until the duplex sold @ $175K via a 1031 exchange completed in Aug 2002 in exchange for a single-family house (SFH) @ $180K. The adjusted basis at that point was $97,500, and the gain deferred.*

The SFH has been rented 100% of the time since then and is assessed at $240K which is what the realtor thinks is probably current market value. The adjusted basis is currently $70K which includes the depreciation and deferred gain.* It is paid off as of yesterday (woo!). The SFH is not in an area I prefer to live. I currently rent a small apartment for my primary residence and I must move out at the end of June.

*Depreciation since purchase in 2002 has been $27,500.

I'm considering:
1. Renting/buying a primary and doing another 1031 exchange now for another SFH in an area in which I want to retire and renting it for 2-3 years, then moving in to the new SFH.
2. Moving into the rental at the end of June for a few months to 2 years and possibly doing upgrades for a 1031 exchange at the end of my time in the house; when I move out, buying a primary/renting again.

Now that I'm aware of the 2008 changes that limit the exclusion of capital gains for property that was converted from a rental to a primary residence, I'd like to consider the costs of both of these options. The only costs I believe I'm fuzzy about are the taxes I'd pay for the non-qualifying time between 2009 and the sale, but please feel free to suggest more as I may be missing them.

For instance, if I sell in 2017 for $275K, would the calculation be as follows? ((275K - 70K * 6/8) + 27,500) * .25
And if I move in, how long could I stay before it converts to a primary and is no longer eligible for a 1031 exchange (assuming they are still available then) - 23 months?

Thanks in advance!

*According to my awesome accountant, who isn't terribly familiar with 1031 exchanges nor IRC Section 121(b)(4). I think she may be learning something new today.



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Old 05-14-2015, 03:03 AM
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Here's the history: I purchased a duplex @ $65K in 1996 and lived in half, then moved and rented both units until the duplex sold @ $175K via a 1031 exchange completed in Aug 2002 in exchange for a single-family house (SFH) @ $180K. The adjusted basis at that point was $97,500, and the gain deferred.*========>So your net adj basis was $97,500 and selling price was $175K, then(if I disregard selling costs of the duplex), then your LTCG was $77500;$175,000-$97,500;however, I guess in this particular situation, as you can see, instead of choosing sec 1031, as you owned the rental unit that has a substantial amount of equity, you may have considered moving into it before you sold/ excahnge it in sec 1031. Doing so can save you substantial capital gains taxes on your profit. I mean as you know well, Perhaps the greatest boon in the tax law for property owners is the $250K for single like you home sale exclusion. This rule permits single homeowners to exclude from their taxable income up to $250K in profit realized from the sale of a personal residence. There is no limitation on how many times the exclusion may be used during your lifetime.
To qualify for the home sale exclusion, you must own and occupy the home as your principal residence for at least 2 years before you sell it. Your two years of ownership and use can occur anytime during the 5 years before you sell and you don’t have to be living in the home when you sell it.
However, a special rule limits the $250K exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home. The rule requires you to reduce pro rata the amount of profit you exclude from your income based on the number of years after 2008 you used the home as a rental in nonqualifying use. Say you buy a home on Jan 1, 2009 for $400K, and uses it as rental property for 2 years. On Jan 1, 2011, you evict your tenants and move into the house, thereby converting it to your principal residence. On Jan 1, 2013, you move out and rent it again. You then sell the property for $700K on Jan 1, 2014. You has a $300Kgain /profit on the sale. You owned the pty for a total of 5 years and used it as a rental property for 2 years before you converted it to your residence. Thus2 of the 5 years , 40%, before the sale were a nonqualifying use, so 40% of your $300k gain ,$120,000, does not qualify for the exclusion. This means that you must add $120k to your r gross income for the year. your remaining gain of $180k is less than the $250k exclusion, so it is excluded from yourr gross income.A nonqualified use can occur only before the home was used as your principal residence. Time periods after the home was used as the principal residence do not constitute a nonqualified use. This is why in the example, your nonqualifying use during 2013 does not reduce your exclusion. Converting a rental into your residence will not eliminate all taxes when you sell it. While the duplex was a rental, you should have claimed an annual depreciation deduction for it each year. The total amount of depreciation you claimed during the rental period is not eligible for the exclusion. Instead, you must "recapture" all your depreciation deductions under the unrecaptured depre or sec 1250 recapture rule that is report them on your Sch D and pay a flat 25% tax on these deductions if yor tax rate is 25% or hgiher. This can have a significant tax impact. In the example above, if youhad taken $10K in depreciation deductions during the time you rented out the duplex, you would have to pay a deprecation recapture tax of $2.5K , 25% x $10K = $2.5K.Imena your excludible LTCG of $180K will be reduced by $2K, sec 1250 ordianry gain.However, there are many tax consequences you should be aware of before you convert a rental unit into your personal residence.

The SFH has been rented 100% of the time since then and is assessed at $240K which is what the realtor thinks is probably current market value. The adjusted basis is currently $70K which includes the depreciation and deferred gain.* =====> No I do not think so; The adjusted basis of $70K does NOT include the depreciation and deferred gain; the adjusted basis of $70K MEANS the original cost minus deprecation taken previously; When you acquire the duplex, you had a cost basis associated with the acquisition.Say, you purchase the duplex rental property for $200K, then, your cost basis will be $200K. If you subsequently remodel the property for $30K , your new basis will be the original basis of $200K, plus the amount you spend on converting the property, giving you an adjusted basis of $230K.Deprevaiiton amount taken previously is say $50K, then your adjusted basis is $225K;$230K-$50K. From the example, it is clear that additions or capital improvements increase the basis of a rental property, whereas depreciation taken previously as rental duplex decrease its basis. The adjusted basis is computed by taking into account all increases and decreases in the property's original basis. Determining the adjusted basis of a rental property is important because you will need it to calculate your gain or loss / sale, which in turn affects your taxable income.


.

*Depreciation since purchase in 2002 has been $27,500.====>>OK so as said previously you must recapture the sec 1250/untrecap depre of $27,500 as ordinary income taxed at 25% aslongas your tax rate is 25% or higher

I'm considering:
1. Renting/buying a primary and doing another 1031 exchange now for another SFH in an area in which I want to retire and renting it for 2-3 years, then moving in to the new SFH.==========>>>>Basically you can do whatevetr you want; you may do sec 1031 excahnge as a rental pty or you convert it it as primary residence for LTCG exclusion on sale of the home.As mentioned above , you may buy a duplex for rental purpose for rental income and then later convert it as primary residence instead of choosing sec 1031, aslongas you own the rental unit, you may consider moving into it before you sold/ excahnge it in sec 1031. Doing so can save you substantial capital gains taxes on your profit..you can exclude up to $250K in profit from the sale of a main home as long as you have owned the home and lived in the home for a minimum of 2 years. Those two years do not need to be consecutive. There is no limitation on how many times the exclusion may be used during your lifetime. I mean you need to have lived in the house for at least 24 months in that 5-year period. In other words, the home must have been your principal residence.


2. Moving into the rental at the end of June for a few months to 2 years and possibly doing upgrades for a 1031 exchange at the end of my time in the house; when I move out, buying a primary/renting again.

Now that I'm aware of the 2008 changes that limit the exclusion of capital gains for property that was converted from a rental to a primary residence, I'd like to consider the costs of both of these options. The only costs I believe I'm fuzzy about are the taxes I'd pay for the non-qualifying time between 2009 and the sale, but please feel free to suggest more as I may be missing them. ======>>>>>>Yes you are correct;however, if you buy a rental home(or even reg SFH and covert it as rental later and put it in sec 1031 as rental home) and use it as rental and choose sec 1031 for the rental home, then the 2013 rule does not apply to the pty UNLESS you convert it as regula SFH.As said above, say, you purchase a home on 1/1/11 and rent it. On 1/1/13, you occupy the pty as your primary residence and then sell the home on 1/1/15 for a $200K gain. Prior to this law change, the entire $200K could have been excluded. However, effective after 2008, you would have to apportion the gain between the periods when it was a rental and when it was a personal residence. So here you owned it 4years, of which time use for 2years was nonqualified. Thus, 50% of the gain ,$100k, would be attributable to a nonqualified use period and would not be excludable. As a result, you would be able to exclude only $100k of the $200k gain and also need to recapture sec 1250 the unrecap depre as said.. Note that had you used the home as a second home instead of a rental, the results would have been the same.

For instance, if I sell in 2017 for $275K, would the calculation be as follows? ((275K - 70K * 6/8) + 27,500) * .25===>>No; then, $275K(SP)-$70K(adj basis)=$195K(LTCG) but as you need to recapture sec 1250 depreciation of $27500, $27500 of $275,00’d be taxed at 25% as ordinary income if your tax rate is 25% or higher; if it is 10% then it’d be taxed at 10% NOT 25%. And the remaining 167,500’d be treated as LTCG and yoru tax rate is 15% or lower then no capital gain tax on it; If your tax rate is 25% or higher then your LTCG tax rate’d be 15%.







And if I move in, how long could I stay before it converts to a primary and is no longer eligible for a 1031 exchange (assuming they are still available then) - 23 months?========>>>>>>>>>>As said above; please read above



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Old 05-14-2015, 02:21 PM
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Question Thanks, a couple of clarifications -

Thanks for the information! My tax rate is 28%. Let's see if I understand:

Quote:
Originally Posted by Wnhough View Post
I guess in this particular situation, as you can see, instead of choosing sec 1031, as you owned the rental unit that has a substantial amount of equity, you may have considered moving into it before you sold/ excahnge it in sec 1031.
I lived in one half 9/96 - 4/98, renting the other half those years after rehabbing it. I then moved across the country and rented both units in 5/98, thus in 8/02 it did not pass the ownership test for the exclusion, so the choices were to sell and pay taxes, or exchange - I chose the latter.

Quote:
Originally Posted by Wnhough View Post
However, a special rule limits the $250K exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home.
I don't think this would apply to my situation, right?

Quote:
Originally Posted by Wnhough View Post
The adjusted basis of $70K does NOT include the depreciation and deferred gain; the adjusted basis of $70K MEANS the original cost minus deprecation taken previously
Thanks, yes - I just typed what she said. I think she meant just what you said: $97,500 (adjusted basis) - $27,500 (depreciation) = $70,000 (new adjusted basis)

Quote:
Originally Posted by Wnhough View Post
However, effective after 2008, you would have to apportion the gain between the periods when it was a rental and when it was a personal residence.
Okay, so see the next question:

Quote:
Originally Posted by Wnhough View Post
For instance, if I sell in 2017 for $275K, would the calculation be as follows? ((275K - 70K * 6/8) + 27,500) * .25===?>>No; then, $275K(SP)-$70K(adj basis)=$195K(LTCG) but as you need to recapture sec 1250 depreciation of $27500, $27500 of $275,00’d be taxed at 25% as ordinary income ... And the remaining 167,500’d be treated as LTCG ... If your tax rate is 25% or higher then your LTCG tax rate’d be 15%.
But isn't only the gain from the non-qualifying timeframe (6 of 8 years it was a rental) taxable? So at that sales price would it be ($27,500 * .25) + ($167,500 * 6/8 * .15) = $25,719?

Quote:
Originally Posted by Wnhough View Post
there are many tax consequences you should be aware of before you convert a rental unit into your personal residence.
Right, which is why I'm here - to be aware of all those consequences, and I really appreciate all the input!

I'm thinking I should move into the SFH I bought in 2002, stay there until next spring, upgrading a few things while I'm there for a better sales price, then do another exchange to a property that I WOULD want to live in for a long time. I'll rent that new one out for two years then move into it, and live in it for the number of years left before my expiration date. I realize if I live in the 2002 SFH for 24 months or longer, it would become my primary residence, and I'd have to pay tax on the LTCG + depreciation.

Does it sound like I'm on the right track to reduce my tax liability (assuming the 1031 remains in place until I can do it again)?



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Old 05-14-2015, 02:23 PM
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Thumbs up Thanks, a couple of clarifications -

Thanks for the information! My tax rate is 28%. Let's see if I understand:

Quote:
Originally Posted by Wnhough View Post
I guess in this particular situation, as you can see, instead of choosing sec 1031, as you owned the rental unit that has a substantial amount of equity, you may have considered moving into it before you sold/ excahnge it in sec 1031.
I lived in one half 9/96 - 4/98, renting the other half those years after rehabbing it. I then moved across the country and rented both units in 5/98, thus in 8/02 it did not pass the ownership test for the exclusion, so the choices were to sell/pay taxes, or exchange - I chose the latter.

Quote:
Originally Posted by Wnhough View Post
However, a special rule limits the $250K exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home.
I don't think this would apply to my situation, right?

Quote:
Originally Posted by Wnhough View Post
The adjusted basis of $70K does NOT include the depreciation and deferred gain; the adjusted basis of $70K MEANS the original cost minus deprecation taken previously
Thanks, yes - I just typed what she said. I think she meant just what you said: $97,500 (adjusted basis) - $27,500 (depreciation) = $70,000 (new adjusted basis)

Quote:
Originally Posted by Wnhough View Post
However, effective after 2008, you would have to apportion the gain between the periods when it was a rental and when it was a personal residence.
Okay, so see the next question:

Quote:
Originally Posted by Wnhough View Post
For instance, if I sell in 2017 for $275K, would the calculation be as follows? ((275K - 70K * 6/8) + 27,500) * .25===?>>No; then, $275K(SP)-$70K(adj basis)=$195K(LTCG) but as you need to recapture sec 1250 depreciation of $27500, $27500 of $275,00’d be taxed at 25% as ordinary income ... And the remaining 167,500’d be treated as LTCG ... If your tax rate is 25% or higher then your LTCG tax rate’d be 15%.
But isn't only the gain from the non-qualifying timeframe (6 of 8 years it was a rental) taxable? So at that sales price would it be ($27,500 * .25) + ($167,500 * 6/8 * .15) = $25,719?

Quote:
Originally Posted by Wnhough View Post
there are many tax consequences you should be aware of before you convert a rental unit into your personal residence.
Right, which is why I'm here - to be aware of all those consequences, and I really appreciate all the input!

I'm thinking I should move into the SFH I bought in 2002, stay there until next spring, upgrading a few things while I'm there for a better sales price, then do another exchange to a property that I WOULD want to live in for a long time. I'll rent that new one out for two years then move into it, and live in it for the number of years left before my expiration date. I realize if I live in the 2002 SFH for 24 months or longer, it would become my primary residence, and I'd have to pay tax on the LTCG + depreciation.

Does it sound like I'm on the right track to reduce my tax liability (assuming the 1031 remains in place until I can do it again)?

Sorry if this is double-posted - I submitted once but couldn't see a third sub-thread



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Old 05-14-2015, 02:34 PM
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Question

Still can't see my replies until I go to reply again - I hope you can see it/them.



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Old 05-14-2015, 08:16 PM
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[quote=Jules;21833]

I lived in one half 9/96 - 4/98, renting the other half those years after rehabbing it. I then moved across the country and rented both units in 5/98, thus in 8/02 it did not pass the ownership test for the exclusion, so the choices were to sell/pay taxes, or exchange - I chose the latter.==>>I see right;as said previously, you, TO EXCLUDE GAIN ON THE DISPOSITION OF the duplex from income , had to own and occupy the home AS A principal residence for 2 of the 5 years immediately BEFORE the sale.For 2008 Act, please read below.I believe trhis is NOT your situation.ASLONGAS it is a primary home, then there is an exceptional tax rule called Unforeseen circumstances that are events you could not reasonably have anticipated before purchasing and occupying the residence.Say, when the seller does not satisfy one of the time rules. The tax law provides an exception to the two-year rules for use, ownership and claimed exclusion when the primary reason for the sale is health, change in place of employment, or, to the extent provided in IRS regulations, “unforeseen circumstances.”
“unforeseen circumstances” if any of these events occur during the taxpayer’s period of use and ownership of the residence:
•death; becoming eligible for unemployment compensation,
;a change in employment that leaves the taxpayer unable to pay the mortgage or reasonable basic living expenses; condemnation, seizure or other involuntary conversion of the property or etc.





However, a special rule limits the $250K exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home.

I don't think this would apply to my situation, right?=====>>As said , unless you converted the rental duplex into a reg primary home before a sale then , I guess not; This is 2008 rule ; when homeowners sell their main home, they can exclude up to$250K as single / $500K as MFJ in capital gains from income tax. The amount of profits from the sale of a house that can be excluded is now based on the percentage of time when the house was used as a primary residence.

The adjusted basis of $70K does NOT include the depreciation and deferred gain; the adjusted basis of $70K MEANS the original cost minus deprecation taken previously

Thanks, yes - I just typed what she said. I think she meant just what you said: $97,500 (adjusted basis) - $27,500 (depreciation) = $70,000 (new adjusted basis)=======>>Correct. We call it as book valuehowwever when you sell it then you can call it as adj basis; I mean adjusted basis of $97500 already entails depreciation taken ; I mean say original cost(basis) is $125K and depreciation amount is $27500 hen your book value(or you may call it as adjusted basis) is $70K;










For instance, if I sell in 2017 for $275K, would the calculation be as follows? ((275K - 70K * 6/8) + 27,500) * .25===?>>No; then, $275K(SP)-$70K(adj basis)=$195K(LTCG) but as you need to recapture sec 1250 depreciation of $27500, $27500 of $275,00’d be taxed at 25% as ordinary income ... And the remaining 167,500’d be treated as LTCG ... If your tax rate is 25% or higher then your LTCG tax rate’d be 15%.

But isn't only the gain from the non-qualifying timeframe (6 of 8 years it was a rental) taxable? So at that sales price would it be ($27,500 * .25) + ($167,500 * 6/8 * .15) = $25,719?====>>>>>you are Correct; matter of fact, my previous calculation above did not account for the gain from the non-qualifying timeframe, so I guess you are correct as you said you need to subtract the gain from the non-qualifying timeframe; ASSUME that the amount is $40K then your LTCG ‘d be $127,500;$167,500-$40K then 15% of LTCG ( also called sec 1231 gain)tax rate applies on the remaining gain of $127,500, so LTCG tax’d be:$19,125;15% * $127,500. Also as your marginal tax rate is 28% then you need to pay tax 25% on your sec 1250 recapture of $27,500 is 6,430;$27,500 *25%;



I'm thinking I should move into the SFH I bought in 2002, stay there until next spring, upgrading a few things while I'm there for a better sales price, then do another exchange to a property that I WOULD want to live in for a long time. I'll rent that new one out for two years then move into it, and live in it for the number of years left before my expiration date. I realize if I live in the 2002 SFH for 24 months or longer, it would become my primary residence, and I'd have to pay tax on the LTCG + depreciation.

Does it sound like I'm on the right track to reduce my tax liability (assuming the 1031 remains in place until I can do it again)?============>>>>>>I guess basically it is up to you so it depends on your decision; as we know you may choose either sec 1031 exchange or you may convert it as primary residence and live in the home for 2 out of 5 years before you dispose of it (even in this case as said above you need to recapture sec 1250 recapture/ the gain from the non-qualifying timeframe. You may need some professional tax help from a CPA/an IRS EA in your local; areas before you make a decision.



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