Tuesday, January 12, 2021 / by Carol Glover
to benefit from available tax tools.
The IRC Sec.
Understanding the interplay of the two tax codes:
Primary Residence-121 Exclusion
IRC Sec 121-The Taxpayer Relief Act of 1997 altered the exemption amounts for capital gains on a personal residence. A homeowner must have lived in the home to be sold for 2 of the last 5 years prior to sale. If this threshold is met, there is a $250,000 exclusion for single individuals and a $500,000 exclusion for married couples filing jointly. For many places in the USA, this exclusion is sufficient to shelter all the capital gain from the sale of a home. However, in the parts of the nation where properties have benefited from substantial appreciation, this good fortune can also be a limitation for those who wish to sell as the capital gains tax reduces their overall net worth, sometimes substantially!
Investment Property-1031 Exchange
IRC Sec 1031-Generally referred to as the "1031 exchange”, offers owners of income producing properties a way to defer their tax liabilities. Put simply, they can exchange a property that they have held as an investment or rental asset ("relinquished property") for a "like-kind" property held as an investment or rental property ("replacement property”). It allows them to defer or put off their income tax liabilities and Federal and State capital gains taxes in most cases.
It is worth mentioning that a property owner or investor can only use a 1031 exchange if the property has been held for investment, rental or business use. The 1031 exchange is not applicable to property held for personal use. For example, property used as a primary residence, vacation property, or a second home do not qualify. However, certain exceptions may apply.
Joining 1031 Exchange and the 121 Exclusion
With proactive and careful tax planning, one can combine the advantages of the 1031 exchange and the 121 exclusion. The result is that, on the sale of a personal residence, one can take the IRC Sec. 121 tax exclusion amounts of $250,000/$500,000 and defer the taxes due on the balance of the net equity by performing an IRC Sec 1031 exchange into an income producing property. There are multiple ways to prepare to take advantage of the combination of IRC 121/1031, and the specifics depend upon your unique situation. However, most homeowners with significant taxable equity find that using this technique upon sale of a substantially appreciated residence they accomplish the following:
1. Avoid or defer all taxes due,
2. Have the cash/borrowing power to acquire a next residence, if desired,
3. Have the cash/borrowing power to acquire an investment property,
4. And have the benefit of additional net income from the investment.
It is critically important to plan well in advance as the timing of the various sale and purchase transactions must occur within a well planned and somewhat narrow window of time to ensure these tax section requirements will be met. We can work with your tax, financial, and accounting professionals to set up your circumstances to achieve this outcome for you.Want to see if you may qualify?
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Carol Glover is a licensed Real Estate Attorney and Broker with Engel & Voelkers. Dave Salzman is the Broker of record for Engel & Voelkers LA- Southbay and they work with clients to create long term planning goals for their clients’ real estate portfolios.