Capital Gains NYC Question and discussion

[Justin S.]

I have a very unique situation I wanted to discuss with the community and all our accountants out there. 

I sold a 3 unit primary residence that I occupied for the last few years in December of 2019. I ended up doing a 1031 on the purchased another Brownstone in Brooklyn. The project required a major renovation and I got a great start on it. Its been stalled for the last month due to the virus and all construction being stopped by the city. Its a 2 unit property and I planned to live in one of the units, but boy are things crazy in the city right now. We are currently renting a house is the suburbs for the time being  and planned on moving back to Brooklyn. My wife is a school teacher and it looks like school will be closed for the rest of the year. 

I am a mortgage banker and have been talking to a lot of my real estate agent relationships and there is major talk of a big decline in NYC real estate values. I have a very large amount of equity in this house and greatly concerned. The fair market rent of the unit would be 6k per month and there is a lot of risk right now out there with unemployment shooting through the roof. I am in a private money loan right now on the property and need a Jumbo loan to get out and the Jumbo market is getting destroyed right now for obvious reasons and rates have increased substantially. 

All that being said, I was reading Publication 523, specifically the unforeseeable events section. 

Unforeseeable Events

You meet the standard requirements if any of the following events occurred during the time you owned and lived in the home you sold.

• Your home was destroyed or condemned.
• Your home suffered a casualty loss because of a natural or man-made disaster or an act of terrorism. (It doesn’t matter whether the loss is deductible on your tax return.)
• You, your spouse, a co-owner of the home, or anyone else for whom the home was his or her residence:
  1. Died;
  2. Became divorced or legally separated;
  3. Gave birth to two or more children from the same pregnancy;
  4. Became eligible for unemployment compensation;
  5. Became unable, because of a change in employment status, to pay basic living expenses for the household (including expenses for food, clothing, housing, medication, transportation, taxes, court-ordered payments, and expenses reasonably necessary for making an income).

An event is determined to be an unforeseeable event in IRS published guidance.

Other Facts and Circumstances

Even if your situation doesn’t match any of the standard requirements described above, you still may qualify for an exception. You may qualify if you can demonstrate the primary reason for sale, based on facts and circumstances, is work related, health related, or unforeseeable. Important factors are:

• The situation causing the sale arose during the time you owned and used your property as your residence.
• You sold your home not long after the situation arose.
• You couldn’t have reasonably anticipated the situation when you bought the home.
• You began to experience significant financial difficulty maintaining the home.
• The home became significantly less suitable as a main home for you and your family for a specific reason.

So, for all the reasons I mentioned in bold above, would it be possible to get out of paying capital gains if I sold? 

If so, a portion or all? Any input would be greatly appreciated. Hope everyone is staying safe out there. 

[Dave Foster]

@Justin S., You handled that complicated split use 1031 like a pro.  And the unforeseen nature of what's happening in the city probably gives you the cover to sell and 1031 the investment portion of the property.  So deferring the tax on that side shouldn't be an issue as long as you and your accountant feel good about your intent (and i know we talked about this being a long term property for you several times).

523 is not for investment property.  It applies to the primary residence portion of the property.  But I don't think it will help you eliminate tax on gain because if you go a little further down that exceptions section you'll see that you have to make an election of when you moved in and when you sold.  Then if the exception applies to you, you can prorate the amount of gain you get tax free.  But you've not moved in yet so there's not any partial relief available.

But... Given the market and everything you may sell and find that there is no gain on the primary residence portion anyway.  You didn't bring in any deferred gain like on the investment portion.  So your only gain would be the difference in price of the primary residence portion.  

So, you've probably got a little homework to do.  But I'm guessing you'll find from your accountant that...

1. You don't have much of any gain to eliminate in the sale of the primary residence portion.

and

2. You can 1031 the investment portion into a new property even though you haven't held it very long because of the nature of your past and current business practices and the whole crazy pandemic scene in NYC.  

That would at least leave you paying no tax  and getting to reposition the asset to a place that is a better fit for you.