Selling or 1031 Exchange? Denver duplex that was purchased as pri

[Shaun Callais]

My wife and I purchased a duplex in Denver last year. It was financed using a primary residence mortgage. We had to put $105k down to qualify, based on DTI. We lived in one side of the duplex for about 7 months, then a new job required us to move about 60 miles away, to another part of the state. We currently rent.

We are currently renting both sides of the duplex. One for $3k/month, the other for $2k/month. Our mortgage (PITI) is $2,300/month, total income is $5,000/month. We spent another $70k on updating the side we were living in. By finishing the basement, we doubled the square footage on our side.

We purchased the property for $550,000 and invested another $75k. Our mortgage balance is $443k. Assuming we were to sell the duplex for $850k, which is what comparable duplexes have recently sold for, we would have $407k - $51k realtor fees = $356,000. Since we have owned it for over a year, it’s possible we would have to pay 15% in long-term capital gains taxes, based on our income bracket. $350k - $175k original investment = $125,000 - 15% = $106,250 + $175k = $281,250 that we would walk away with. Is this correct?

Another option we are looking into is doing a 1031 exchange, but it would need to meet the needs of my family. We want to purchase a home in a Denver suburb about 8 miles away next summer to live closer to family and be in a better school district for our son, who is in special education and is experiencing increased behavioral challenges. We would look for a single family residence with a mother-in-law suite. We doubled the square footage of the duplex unit our family lived in from 874 to 1,750, and the side that has always been a rental is still 875 square feet.

I am also looking to move to another career, as I am currently in a commission-only sales job and have not made the amount of money I had anticipated, due to supply chain and payroll delays (needing to wait 4-6 months to get paid on my sales). I’m concerned that I won’t qualify for a $650k mortgage next summer without this job showing on 2 years of tax returns. Fortunately, our rental will show up on 2 years of tax returns, as $5k/month of rental income since August 2021, but only $2,400 of rental income in 2020, as the previous owner hadn’t raised rent since 2012. I have an MBA and should be able to find a job that pays $80-100k/year, with my experience.

Please advise on the best option(s) for our family, as well as if I am missing any key info needed to make this decision. If we kept the duplex, would the $5k in rent be enough to offset the $2,300/month mortgage, for DTI purposes? Assuming we only deduct PITI and depreciation from taxes, no repairs. Is the 1031 exchange from a duplex to a SFR with a mother in law suite realistic? If we kept the rental we would need to go through Penfed Credit Union, or another financial institution, to take out a HELOC on the duplex to use as a downpayment on a new house. Is there any way we can possibly avoid paying long-term capital gains taxes if we sell, besides through a 1031? Thank you!

[Dave Foster]

@Shaun Callais, some off your questions need to be addressed by a lender.  But here's another twist on what you could do.

1. Do both a 1031 and take the primary residence exclusion on the current duplex.  Yes, you only lived in it for 7 months.  But you were forced to move for job related reasons.  That should qualify for a partial exemption.  It looks like the gain associated with the one side you lived in will be around $150K.  You should be able to take $43000 ish tax free.  That can tide you over in your short fall for a bit.

The rest of the gain from that side and all of the gain from the other side you would do a 1031 on.  

2. As a 1031 replacement purchase an investment property with a mother in law suite and treat both as investment for year or so while you transition back.  Then convert the main part of that property to your new primary residence.  Keep renting the other part and voila you've taken some profit tax free and deferred the rest into your new primary residence.