Capital gains tax on a four unit that I lived in for 4 years-1031

[Thomas Bryan]

Hello BP! I have a few questions regarding the sale of my four unit apartment that should be a CPA's dream! I bought the building in 2013 for 74,000 as a three unit that needed work. I since converted it into a four unit and lived in one of the units from 2013-2017. I now have a buyer interested in the property for 165k. So... (1) Since I lived in the property for two of the last five years am I exempt from all of the capital gains, or a quarter of the gains? (2) I have a HELOC (home equity line of credit) on the property that I did not utilize. Can I use the HELOC before the sale to add more debt to the property to lessen the gains? Is that frowned upon? (3) I will be looking to do a 1031 exchange if I need to. The purchase I have in negotiation would be a portfolio of several rentals that would be purchased under owner financing. Can I still utilize a 1031 exchange for the down payment to the seller with a seller financed deal? Any help on this would be greatly appreciated!

Thanks!

Tom Bryan

[Dave Foster]

@Thomas Bryan,  It's not nice to upset CPAs this time of year....:)  Actually your questions are pretty straightforward.

1. You will be exempt from 1/4th of the gain up to the limits of the sec 121 exclusion assuming that all units are identical and your accountant set up the depreciation schedules with those equal allocations.

2. The amount of loan does not impact that amount of gain recognized.  So tapping the heloc prior to sale will not save you taxes.  In fact it will jeopardize your 1031 if you choose to go that route.  Your gain is determined by the difference between your adjusted cost basis (acquisition plus cap expenditures minus depreciation) and the net sales price - debt is not a factor.

3. Absolutely - purchase of a property with owner financing is the same as a purchase with bank financing.  As long as you purchase at least as much as you sell and use all of the proceeds in the next purchase you will completely defer all tax in the 1031.

4. You didn't ask but to confirm - yes you can combine sec 121 primary residence exclusion and a 1031 exchange to complete eliminate and defer all tax on gain from the sale - a great strategy.  The gain from the primary is tax free and you can do what you want with it.  the gain from the sale of the investment allocation is tax deferred indefinitely.