By Michael Edlen
Special to the Palisades News
I am frequently asked if there is a way to sell a long-held family home without paying what owners feel are excessively high taxes.
One might consider that the buyer today is paying 25-50 percent higher prices than they would have not many years ago, which might well cover any taxes from the gains.
Another approach is to convert the home into income property, and subsequently sell it using a tax-deferred 1031 exchange.
Federal law currently allows taxpayers to defer capital-gains tax on the exchange of property used in trade or business or held for investment. The 1031 exchange postpones but does not eliminate taxes. How- ever, with the transfer of that property to an heir, the basis of the property is stepped up, thus essentially eliminating the taxable gain.
Many seniors have acquired investment and commercial properties and are often familiar with the 1031 exchange process and its benefits. The process involves an exchange of like-kind real estate, and is essentially treated under the tax code as a continuation of the ownership of property rather than a taxable sale. It is thus a method of equity preservation available to owners of investment and business property.
The role of a real estate professional in such an exchange is bring buyer and seller together in a sale contract.
A buyer and seller must consult with appropriate legal and tax advisors, and the actual exchange is nearly always done through a qualified intermediary or accommodator. Most experienced real estate agents will be familiar with the concept, and will also be able to assist clients in finding the appropri- ate experts to handle the exchange details.
In addition to conserving capital assets, tax-deferred exchanges may increase equity by the deferral of capital gains tax and enable acquisition of property that may be more valuable or have greater appreciation potential. It can also be used to divide real estate holdings prior to distribution to heirs and increase net cash flow by better asset allocation.
Some families may use such an exchange to acquire a future retirement home or to obtain non-taxable cash by trading for property that can have a loan placed on it later. There are special tax rules that apply to such exchanges, and again all parties are encouraged to consult with appropriate tax professionals.
Since a personal residence is not eligible for exchange, it must first become investment property. This will require the owners to move out of the home and lease it for two years at fair market value. Of course, if this approach is used, the owners will be giving up the current ability to claim the $250,000 ($500,000 if married) capital gains exclusion on the sale of a principal residence.
If the family owns a vacation home that has only occasional rentals, one’s tax advisor will most likely counsel that its sale will not qualify for a 1031 exchange. This is because personal use has been the home’s primary use.There are very specific rules and procedures for planning and doing a 1031 exchange, and a real estate agent and other professionals must be familiar with them to minimize being challenged by the IRS. Also, the exchange requires “like-kind” properties be involved. This does not so much refer to the type of property, per se, as it does to the use of the property.
For example, the family home that becomes a rental property could be exchanged for an apartment building, or vacant land could be exchanged for an office building, etc. Some of the basic rules include time limits for the identification of the replacement property (45 days from transfer of the relinquished property) and for the closing of escrow on the acquired property (within 180 days). Tax experts must be consulted to be sure the requirements are properly being met. While this may sound like a complicated procedure, it is one alternative to the question about how can one sell a long-held personal residence and not have to pay large capital gains taxes.
(Michael Edlen is a certified Seniors Real Estate Specialist. Call (310) 230-7373 or email Michael@MichaelEdlen.com.)
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