Question

Joyce, a retired widow in good health, would like to someday move to be near her son and future grandchildren when he finally settles down. What would you recommend for tax planing purposes, so she could maximize the gains on the sale of her present home in Wausau and her lake house in Eagle River? Be sure to site any sources, tax code, and documentation she should have to support the tax position.

Answer 1

As per IRS, an individual can exclude up $250,000 of profit on a home sale from their taxable income; a married couple can exclude up to $500,000. In general, to qualify for the Section 121 exclusion, you must meet both the ownership test and the use test. You're eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. Generally, you're not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.

Also, as per IRS, capital gains on tax real estate investments are due in full in the year in which you sell the property. However, if you are liquidating a real estate investment and plan to purchase another, you can put off paying capital gains tax by taking advantage of IRS Code Section 1031 and rather than selling your property, exchange it for a like-kind property.

IRS Section 1031 defines like-kind properties as those “of the same nature or character, even if they differ in grade or quality.” In general, the IRS considers all real estate within the U.S. – whether improved or unimproved – as like-kind. You can use Section 1031 to transfer all capital gains to new property if the exchange is pure and money does not change hands, or transfer a portion of capital gains to new property if in addition to an exchange of property you also receive a sum of money. In this case you will need to pay tax on the money you receive.

You can get the property ready for sale, list and sell it and then appoint a qualified intermediary, such as a representative from your bank, to handle and hold the funds from the sale until the exchange takes place. IRS regulations state that a QI cannot be a family member, business colleague or anyone with whom you have a personal relationship. Instead, the QI must be a representative of an independent organization whose only relationship with you is to serve as a qualified intermediary.

IRS regulations identify three main requirements for conducting a 1031 like-kind exchange. First, the exchange must be an investment-to-investment or business-to-business exchange. Second, you have a 45-day window from the day your sell your investment property to find another and produce a written sales agreement. Third, you must complete the transfer and close the deal within 180 days of either selling your investment property or by the date you file your tax return for the year.

So, Joyce can sell her present home and lake house and can purchase another property as per the provisions of section 1031 and she will not have to pay the capital gain tax on the proceeds of the sale of property.