1031 Exchange, Section 121, any other tax strategies?

Question

I purchased a single family in May '17 as my primary residence shortly before listening to BP podcasts and researching real estate. While I love the home, I have since realized my mistake and shudder when I think of the things Grant Cardone would say to me. I am interested in selling my house and purchasing an owner occupied multifamily but I am hesitant as I just paid $7k closing costs, will have somewhere around $7-10K closing costs on the multi and will pay a 4% agent fee for the sale of my residence. I am fine eating a few thousand up front to benefit in the long run, but will still need to sell my house for a profit (let's ignore whether or not I can get X dollars above what I paid just 6 months ago). On top of the expenses I already listed I would like to avoid capital gains taxes on the sale.  My questions are below:

1). I do not believe I qualify for Section 121 as I have not had any life changes that would fall under this category - they all seem like they are beyond one's control. Does anyone have experience getting creative with these guidelines?

2). My understanding of the 1031 Exchange is that a single family can qualify as long as there is proof that it is an "investment property". A family member is going to be renting a room starting in 2018, what do I need to do in terms of paperwork/documentation, and how long do I need to rent it before I can show intent that it is an investment property?

3). Are there any other strategies that may allow me to avoid capital gains taxes?

Thank you!

Nick

Vlad K. · Answer

@Nicholas Hamel Nick, in your scenario you would pay it on $6k, which would be reduced further by closing costs (excluding prepaids) you paid on purchase and sale.

You are absolutely right, there is no harm in listing. If you don't mind starting your investment path by house hacking, that's the way to go. No reason to carry multiple mortgages.

Vlad K. · Answer

@Nicholas Hamel, if you have purchased the house in May 2017, how likely it is that you will have a gain on sale of the house after paying commissions and other fees? Remember, you do not pay capital gains taxes on the sale, you only pay taxes on the gain, if any (if you have a loss, you don't get any deduction since it was your residence).

The first step would be to figure out if you even going to have a gain on the sale. Your closing costs of $7k might not even be $7k. In many cases, closing costs include escrow deposits for taxes and insurance.

Let me know if you would like to chat, but after owning a house for 6 months, it is unlikely you would have gain on sale.

Filipe Pereira · Answer

Hey Nick, you sounds like you are well studied in what you are trying to do. I always thought there had to be a seasoning period, but recently learned otherwise. I am not a CPA, but @Vlad K. is, and hopefully he can chime in to help you out.

Are you financially strong enough to carry both mortgages in the event that you need to let your current SFR season as a rental?

Sam Shueh · Answer

I will be surprised that 6 years later, the tax law requirement will stay the same. Congress is trying to make it restrictive so stay in tune.

Nicholas Hamel · Answer

@Vlad K. I appreciate your response.

I agree it is not guaranteed, or maybe even likely I would see a gain on such a recent purchase but there would be no harm in listing if it may allow me to purchase an investment property sooner.

Listening to what you are saying on cap gains, using hypothetical #'s, if I bought the house for $90k and sold for $100k I would pay a 4% commission for the sale of $4k. Would I then pay cap gains on $10k (100k - 90k) or would I pay it on $6k? (100k - 90k - 4% commission)?

In regards to closing costs, I should have said "closing costs & prepaids" - but either way this is money I have paid out of pocket already for my single family primary residence, and money I will have to pay out of pocket when purchasing the multi.

The root of what I am trying to accomplish is trying to use the capital I have "stuck" in my single family I.L.O saving and waiting or using another creative financing avenue. Maybe there is another approach I am not seeing but am all ears and appreciate the reply.

Nick

Nicholas Hamel · Answer

Hi @Sam Shueh thank you for the post. I do not currently have an investment property, the idea is that my single family primary residence would become one starting in 2018 when my family member begins renting out a room. I would then be looking to have that qualify my single family primary residence as an investment property in order to use the power of the 1031 exchange to get into an owner occupied multi.

Thank you for weighing in,

Nick

Nicholas Hamel · Answer

Hi @Filipe Pereira, thank you for your response. I could carry both mortgages, but I would not be able to cover a downpayment + what I would like to have in reserve for my own residence as well as a multifamily. I am exploring other options of partnering & owner financing through a private cash buyer, etc. but my goal here would be to use the equity I have in my single family to purchase an owner occupied multi.

Thank you for bringing Vlad in the discussion!

Nick

Sam Shueh · Answer

How many years have you owned the investment property for the sake of generating income 100% from that investment property and how many years you have reported to IRS with income, depreciation, expenses claimed.  I suggest you talk to your CPA first.

1031 Exchange, Section 121, any other tax strategies?

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