Minimizing taxes implications on primary residence: 121 plus 1031

[Curt Wortman]

I'm considering selling my primary residence and moving out of state... yes I'm from the amazing overpriced California. Before making any decision I'm researching what are my options for minimize the tax implications. I will be purchasing a property on the East Coast at a fair less amount taking any remainder gains and purchase rental income properties.

Background: I have lived in my home for 10 years watching the prices of house steadily climb. From my research on 121 capital gains exclusion, this would allow for $500K tax free since I'm married. The challenge is to minimize the tax penalty on the remainder of capital gains. From a simplistic calculation the remaining taxable income = Purchase Price - Sale Price - $500K from 121. The rental income of this California would be ~$4k/month which only covers existing mortgage and property taxes, therefore much better ROI for cash flow elsewhere assuming that appreciation would remain flat for the next few years.

My limited understanding:

1. If you live in the residence for 2 of 5 years, then I can apply for the 121 benefit. Check!

2. 1031 exchange could be used within the 3 year remaining. Proper handling of identification and conversion per the 1031 stated timeline would be required.

Do I need convert the property to a rental to take advantage of 1031 exchange? If so, then how long do I need to wait selling this newly converted rental property?

I would like to hear from the experts if they have any creative solutions to minimize taxes. I will be using a CPA in conjunction but there is a broad spectrum of knowledge in the forums that might result in some better options...

[Dave Foster]

@Curt Wortman, You can take advantage of whatever part of the code you qualify for.  

1. For. your primary residence if you have lived in the property and owned it for 2 out of the 5 years prior to sale you get the 121 exemption.

2. If the property is being used for investment when you sell it you can do a 1031.

3. So it is possible to move out of your primary, use it for rental for up to 3 years, sell and take both the 121 and 1031 options.  In this example you will have to recapture depreciation during the time it was an investment property.

4. If your gain is more than $500K this is a great way to mitigate that.  Convert into a rental for a year or so and then sell and start a 1031.  Take $500K of boot (normally taxable but not this time because of 121).  Do a 1031 on the remaining and defer all the rest.

The one thing this doesn't help with would be your new primary.  You cannot do a 1031 into your primary residence unless you use it for investment first for a while.  But... This about this scenario - Move out of your house for a year.  Then sell and do the combo 1031/121.  Don't buy your new property initially.  Instead rent for two years or so (the year before you sell your old property and the year after the 1031 is complete).  Use the 1031 to buy a really nice investment property and use it for investment while you are renting where you are.  After your lease is up you decide to convert the property from investment to your new primary residence.  Everything tax free or tax deferred and you get a new primary out of the deal.

Yes, it works!!