Property sale needed quickly
Many of you may be aware of the tax deferral benefit that a 1031 Exchange provides. It allows you to defer the capital gains tax liability indefinitely by carrying it to the next property. However attractive that deferral seems, you may eventually have to pay that tax at some point after the property sale. But if you are patient and willing to wait a few years, you can wipe away a certain amount of tax liability as opposed to simply deferring it.
Section 121 of the Internal Revenue Code is called the Principle Residence Exclusion. It says that if you sell your principal residence that you’ve lived in for two of the preceding five years, then you can exclude up to $500 thousand dollars of gain if you’re married, and up to $250 thousand dollars if you’re single. Under Section 121, you are not merely deferring the tax liability to the next property - you are wiping it away completely. So why do a 1031 deferral, when you can do a 121 exclusion? Combining the two has proven to be a popular strategy for many savvy taxpayers.
There is a loophole that allows you to continually defer the tax liability through multiple 1031 Exchanges, and eventually exchange into a property that is hospitable as your principle residence. The IRS has not closed this loophole completely, but instead modified it by saying that you have to wait five years after completing the 1031 Exchange before you can take the 1021 Exclusion. What this means is that after exchanging into the property, you can rent it out to tenants for three years (this shows the IRS your intentions to hold the property for investment purposes). After three years, you can evict the tenants and move into the property for two years (this satisfies the section 121 requirement that you live there for two years). Then you can sell the property, which was your principal residence for two years, and exclude up to $500 thousand dollars of the gain if you’re married, and up to $250 thousand dollars if you’re single.
One major caution here - when you are looking for property to eventually occupy as your principal residence, be sure to read the Declarations and Covenants and Restrictions. You may be restricted, or prohibited entirely, from renting out the property. Renting out the property is key, as the 1031 provisions do not allow you to immediately live in the property.
When renting out the property, you may have to pay a small amount of tax for the depreciation recapture. But still, the end benefit of a combined 1031 Exchange/121 Exclusion is something that may cause you to look twice at your next 1031 replacement property.
sell property quick
