Capital Gains Tax on New Home

[Kimberly Kim]

Hey BP! I purchased my first SFH less than 2 years ago (May 2019), but am in the process of selling to live with my SO and to aggressively save to pay off my student loan debt from grad school. My house value has increased $60K, but I know that I will have to pay capital gains tax since I haven't lived in it for 2 years. Would I be able to use that profit towards the down payment of a rental property, such as a duplex, and not get taxed? From what I understand, the 1031 Exchange only applies from rental property to a-like rental property, and not from primary residence to rental property. Also, is it smarter financially to use those gains to pay off student loan debt (interests rates range from 5-7%) or buy a rental property? Thanks!

[Dave Foster]

@Kimberly Kim, You've got it correct.  As it stands right now you'll incur tax.  The 1031 doesn't apply because the property is not currently being used for investment.  And you don't qualify for the primary residence exemption because you haven't lived there for 2 years yet.

A couple of thoughts for what its worth:

1. If your gain is $60K you're looking at around $9K in taxes.  If you wait until May to sell you'll save that $9K.  Is it possible for your SO to move in with you for a few months.  Or you to arrange a lot of time with each other without "living together" for a few months.  $9K seems like a lot of money just to share a tooth brush :).  Think about keeping your primary residence as is and selling once you hit the two year mark.  

2. Your savings comparison of buying real estate vs paying off student loans is a really good connection to make.  I've got an admitted bias against student loans.  And would strongly advise you to get rid of student loans any way you can any time you can.  They are the worst handicap to 90% of college and trade school students!!!  EXCEPT - Right now I'm actually telling my children (who are currently debt free) to take out student loans and put them in a bank account just to hold.  It would appear that the incoming administration is determined to forgive student loan debt.  So it might not be advantageous for you take hard earned profit and honor a debt that others will get for free??!!  

If ever there was a time to load up on student loan debt and buy real estate this is it unfortunately.  And the advantageous interest rate you can get on real estate loans will help to offset the impact of the 7% loans.