1031 Exchange good in this situation?

Question

I currently own two houses. First house is going to be on the market for sale next week. I bought it in 2005 for 273K and I am listing it for 600K. I rented it out for 4 years (2017-2021) and depreciated it during that time (29,300 depreciation). I did not want to continue to rent it out after Covid moratorium and Oregon rent control laws, so did not renew the tenant's lease. My husband and I planned to move back in and sell our other home but he got very ill and we were unable to make the move. He passed in 2022 (appraisal for that date said 525K-550K) I have been on the fence about moving back there, selling or renting. I decided to fix up (20+K expenses in the last 3 months) and have signed the realtor contract last week to sell. I intended to sell, buy a one level with the proceeds and take the capital gains hit. I own the home I will be selling. I carry a mortgage on my other home that is valued at about $480K with a 300K loan @ 2.25%. I would probably keep the other house regardless of what I do because of the low interest rate.

I am now wondering if I should hire a Qualified Intermediary (my realtor calls this an "Accomodater") so I have the option to buy a one level rental, stay where I am at, and if in the future I am unable to live in the two level home I am currently living in (our second home that is my primary residence), convert the rental to a primary residence. I assume I would lose the fee I would pay the intermediary if I do not complete the 1031. It seems like it might be in my best interest to do the 1031, buy a rental that is one level and continue where I am at for the time being, rather than buying a primary with the proceeds and taking the tax hit... Thoughts anyone, and what kind of fees would I be looking at paying the Q.I. I realize I have to intend to rent the new property in a 1031 - which I would intend to do. Also, are there other things I may not be taking into account, other than "quality of life" issues?

Basit Siddiqi · Answer

Calculate the gain and tax implications of a sale.Do you have any passive loss carryforwards to offset the gain?If the tax is signifcant, you should consider doing a 1031 exchange.

P. Kaye M. · Answer

Thanks, Dave

I appreciate the input. I posted a question in another category regarding this, also. I am hoping to start a 1031 exchange and I am wondering if I would qualify before paying the fees to set one up. My estimated basis, stepped up, is about 459K (that is 1/2 of my basis of 273.5K + 20K improvements and 1/2 the value at time of my husband's death of 585K) + 20K upgrades this year to sell. Net sale will be approximately 565K. My net sale will be about 565K. I have made an offer of $570 on a replacement property. I need to get this in place if it is doable. I know I am not doing things in the best order but things happened fast once I decided to sell...

Another question for you Dave, Is a Qualified Intermediary the same as an "Accomodater". My realtor mentioned the later that works with the local title insurance, but when the realtor spoke to her about my situation she said I needed to check with a CPA to see if my sale would qualify as a 1031 and that she is just the "accommodator" of the money as it exchanges hands. I am not sure who I should be dealing with to get all of my ducks in a row.

Dave Foster · Answer

@P. Kaye M., If your calcs are close then you've got around $100K of gain.  That would probably be a $20K tax bill.  The replacement property you are looking at would be a great replacement to meet your reinvestment requirements.  For you the question will be is it worth it to spend  less than a thousand on an exchange to save $20K in taxes.

To your other question - Qualified Intermediaries, exchange facilitators, and exchange accomodators are all the same thing.  They are the unrelated 3rd party who documents the exchange at the sale and purchase and holds the proceeds in between.  They are independent from the title company.  But many title companies will have a relationship with a national QI firm like us.  That escrow officer was exactly right.  Your accountant will be the one who you want to determine if the exchange qualifies.  The qualified intermediary or accommodator will perform the actual exchange.

I sent you a colleague request if you have further questions.

Dave Foster · Answer

@P. Kaye M., @Matt Devincenzo is right that the step up basis will help.  But you still have quite a bit of appreciation just on your half I would imagine.  Like @Basit Siddiqi says you really need to calculate the basis before going much further just to confirm.  But I'm guessing that the 1031 exchange is probably the way to go.  And you could buy something you might like to convert into your primary in a couple of years.  Starting a 1031 isn't expensive.  But it keeps your options open.

Matt Devincenzo · Answer

@Dave Foster will be able to help with this...the first question I have is have you actually established what the capital gains amount may be? Your stepped up basis due to your husbands passing may make the tax hit much much lower than you think. Also what is your actual sale price for the listing?

Don't keep your home because of the low interest rate. It's a nice benefit while you live there, but it shouldn't be the deciding factor in what you do next...it can play a part in the discussion, but the much greater benefit is your ability to sell tax free on your personal residence with a 121 exclusion.

P. Kaye M. · Answer

Thanks, Matt

I do see where the stepped up basis will help quite a bit. Unfortunately, Oregon has a 9.9% tax rate on capital gains in addition to the federal tax. I think I will be looking at CG tax on about 120K after deducting for depreciation of about 29K but then have the recapture tax. I don't think I will be hit with the 3.8% additional tax. I believe the actual sale price of the house will be 600K but I will deduct the selling expense fees. My cost basis was originally 202K for the building plus about 30K improvements. I do wonder if I would be better off just paying the taxes and not messing with the 1031 and having a new primary home so I could sell or rent the other. I agree that I shouldn't keep it just because of the low interest rate. But I also think that if I can rent it to cover the payment and expenses, why not let someone else purchase the house for me and keep it indefinitely...Then there is the fact you mentioned about the 121 exclusion, which I would qualify for now...a bit overwhelming making these decisions so thank you for your insight.

1031 Exchange good in this situation?

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