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Turning Investment Property Into Tax Free Cash
A
little-known, but increasingly
popular way of turning investment property into
tax free cash is to sell an investment
property, such as a duplex, and then roll the gain
-- tax deferred -- into a single
family residence via a 1031 exchange. To qualify
for the exchange you have to hold the new residence
as investment property for at least a year and a
day, and our clients typically do this by renting
it, or trying to rent it during this time. Once
this investment period is up, they then move into
the residence and convert it to their home. Under
'current' law (Section 121 IRC), if you live in
a home as your primary residence for at least two
years, the exclusions from capital gains taxes available
to you when you sell it are up to $250,000 if you
file a single return and up to $500,000 if you file
a joint return.
So for example, Fred and Sue sell their purple duplex
and defer their $400,000 gain by buying a single
family rental house. They have to rent, or try to
rent this house, for a year and a day before
they can move into it (so as to not invalidate their
exchange).
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by
Tracey Wilson, Consultant, The 1031 Exchange
Experts |
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Under
the old law, they could move into the house (after their
one year and one day) and live in it for the
next two years, and then sell it -- and the
first $500,000 of gain would be excluded, even if $400,000
of the gain was rollover gain from their 1031 exchange.
By
effectively using two different sections of the tax
code (Section 121: sale of your primary residence, and
Section 1031: tax-deferred exchanges) you completely
'vaporize' your capital gains taxes (up to the limits
mentioned)! You've not only deferred your gains through
a 1031 exchange, but eventually eliminated the capital
gains up to the exemptions noted -- You've turned investment
property into tax free cash!
How long before the IRS catches onto this eloquent exit
strategy?
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| Well,
in a bill that was just recently signed by President
Bush on October 22, 2004 the time requirements for owning
the house in order to get the exclusions under Section
121 are now extended to five years.
Under
the new law Fred and Sue will have to own
the house for at least five years, and have lived in
it for at least two years in order to exclude the gain.
Actually, this new law, having to own your primary residence
for five years, is not too bad -- the IRS could have
just done away with this entire scheme, but instead
merely modified it so that the magic of vaporizing your
capital gains now just takes an extra two years!
Make sure that you use a Qualified Intermediary that
knows how to structure your exchange with this strategy
well thought out in light of the new laws.
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