Avoid capital gains/reinvest?

Question

Greetings folks,

I may be taking a job in the Spokane area which means my California home will be sold.  I owe $220k and Im very sure that I could sell it for close to $600k.  Im trying to figure out a way to avoid capital gains if i can...I think dumping all of the money into another house is one way to do it, which would mean id have to refinance to get my investment money back out.  Im not married yet and we dont file jointly so that means id have to pay the taxes...i think.

What id like to do is buy a home for around $400k ish mark in the Spokane area with 20% down and invest a large portion of the left over money.  Can you 1031 exchange that original income money?

Basically what im looking for is what would you do to shelter the money/reinvest given the circumstances?

Thanks in advance!

Michael Thach · Answer

1031 exchange does not apply for primary resident as I remember right.

Maybe there is another way, since you only owe 220k on yours and have build some equity in home in Cali. Why not cashout refinance the amount you need for the 20% down on a 400k home, which is 80k. So you would total owe 300k and I am quite sure you can rent your current Cali Home for more than 1300 USD. So You have someone paying your 300k mortgage and make some positive cashflow to help you pay your Spokane property. And no capital tax. You still keep 2 houses and they can appreciate further + cashflow.

Jon Schwartz · Answer

Eric, I think you might be calculating your profit incorrectly. You profit is sales price minus basis. Basis is what you paid plus any improvements you made. The loam amount due, I think, is irrelevant. For example, if I bought a house cash for $1M, then sold it a year later for $1.1M, I'd owe nothing and my profit would be $100K.

What did you buy the house for? And did you make any improvements? As a single filer, you're allowed $250K of profit without paying any capital gains taxes.

David M. · Answer

@Eric Phillips

1031 exchanges are only for investments.

As a single filer, you get $250k of your capital gain excluded per Sec121

“Reinvesting” your money doesn’t do anything to your tax liability.  Have you ever invested in stocks?  When you sell the stock you derive a profit/loss depending on your sale price and cost basis.  Just because you take the proceeds and buy more stock doesn’t eliminate your tax liability of the realized profit/loss.

I have never done it, but an installment sale might help.  Basically, you get paid over time, in your case say two years.  The point is to spread out your capital gains over more than one tax year to keep you in a lower marginal tax bracket which saves you a few pennies on the dollar.

I’m not the professional here, but I believe those are your only real non-morbid options.

Good luck.  Sorry I couldn’t be of more assistance.

Scott Green · Answer

Eric, Johnathan is right on.  The gain on your residence is a function of what you originally paid for the property + capital improvements = your adjusted basis in the property (how much you owe on the property doesn't factor into the equation).  You subtract that number from your sales price less closing costs, and you have your capital gains that would be realized on the sale of your primary residence.  You exclude $250k of the gain if you file singly.  What you reinvest in doesn't affect the amount of the exclusion.  The 1031 works only for investment property thus it is a non-factor.  Bottom line is that if your gain is under 250k, you won't recognize any capital gains taxes.  If it is over 250k, you will pay some taxes in the sale of your residence.  Good luck with your move to Spokane, home of the Zags....

Marc Rose · Answer

@Eric Phillips

Why not roll all of your equity into the new house, have no house payment, and invest what would have been your house payment each month?  In a few years you will be in a great position

Devin Redmond · Answer

Like @David M. and @Scott Green mentioned, your best strategy is probably to take the $250K owner-occupied cap gains exclusion. If you sell for $600K, you're going to net closer to $560K after commissions and closing costs. If your basis is $270K, then your gain is roughly $290K. That only leaves about $40K subject to cap gains taxes.

If there was more left over, you could consider renting it out for a year before selling to convert it to an investment property. That would allow you to get the best of both worlds. In that scenario, since it's still true that you lived in it for 2 of the prior 5 years, you can then exclude the $250K and 1031 the balance of the gain into a new investment property. In your scenario though, it's probably not worth the hassle and timing risk to defer only $10K or less from taxes.

Either way, it's absolutely worth buying an hour of a good CPA's time to work through the specifics of your situation. Nothing in this post should be construed as actual tax advice!

Eric Phillips · Answer

I thought about doing that but to be honest, renting anything in California is way too sketchy for my taste.  The home is at its peak value for the area and i would love nothing more then to wash my hands of this state.  Kudos to anyone brave enough to be a landlord in this state.

I could buy several homes in the midwest in landlord friendly states and profit far more as far as cash flow goes.  Thats more of the direction i want to head...im just not sure how long i have before i pay capital gains.

I think youre right on the 1031....i suppose its only for non primary.

David M. · Answer

@Eric Phillips

Well, you shouldn't be looking at the "web" for tax rates.  Look at California's website at their actual tax forms.  Anyway, quick look indicates it follows the Federal methodology.  So, depending on your AGI, you are probably doing 15% both to Federal and CA.  YIKES!  But, I don't do CA state taxes.  Consult a pro.  Good luck.

Bobby S. · Answer

@Eric Phillips since you want to wash your hands with this state, investing in a opportunity zone is probably the best option if you don’t need that capital on hand immediately.

I was going to recommend turning it into a rental property for about a year prior to selling because at that point it would become a 1031 exchange.

Another option for selling your home is a Section 121 exclusion. You would have needed to live in the home for at least 2 of the last 5 years. It will allow up to an exclusion of 250k for a single filer and up to 500k for joint filing.

Hope this info helps. Feel free to reach out directly if you have questions about Opportunity Zone Investing.

Joe Cassandra · Answer

Another idea is to dump the money into an Opportunity Zone. Taxes are then deferred for 5 years.

I don't fully understand the law, but worth checking out

https://www.forbes.com/sites/t....

Check with a CPA as well...you may be able to put 50k or so into a self-directed IRA and defer taxes...

Invest the money into marketing or find a large expense you can deduct now that you can get use from for years (maybe a business car etc)

Avoid capital gains/reinvest?

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