Capital gains question on sale of condo

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Capital gains question on sale of condo

Mike H.
Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes

Hello BP !

wife bought a condo in NYC 15 years ago.  We lived there til we had a baby and moved out to rent a 2 bedroom.  We wanted to list it sooner but life and covid got in the way and are going to list it in a few days.  Sept 10th will be our 3 year anniversary of vacating the property.  Talking to our realtor she said even if we got an offer today it will be a challenge to close by 9/10.  Typically it takes 45 days to close here.  There is attorney review.  Condo board approval etc.  

If we do actually sell the property it will be a good problem to have.  So not too big a deal.  If we get asking price we will have about 150k liable for cap gains tax.   I'm assuming there's no wiggle room on the 9/10?  Like if we close 9/20 IRS won't say "well close enough" ?  

If we close after 9/10.  I guess our options are to buy another investment property with the 150k to avoid paying the 20k in cap gains.  our family is considering buying a lakehouse together.  I'm assuming we couldn't put the 150k in to the lakehouse as a 1031 exchange cause that would be a second home - not an investment property... 

Any thoughts on our situation?  Thanks!

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
6y
Originally posted by @Mike H.:
Originally posted by @Justin Schmid:

@Mike H. I’m not a tax attorney but I believe you could temporarily move back in (just put a bed in and sleep there. Until you close that way if you go past the Sep. date, you will have homesteaded 2 of the last 5.

Haha!  very interesting thought.  I don't know i'd have to run that one by the wife.   

No need to run it by wifey. Justin's suggestion is well-intentioned but very counter-productive. It will screw up your eligibility for an exclusion by triggering the nasty "non-qualified use" rule. That little-known rule will force you to pay a portion of capital gain tax even if you could avoid it otherwise. Do NOT move back unless necessary for life reasons.

However, you actually might have a reprieve from the 9/10 deadline due to Covid. There're IRS Regulations that allow for an exception ("reduced maximum exclusion") under "unforeseen circumstances." While there is no black-and-white safe harbor rule for your circumstances, I have a feeling that we could interpret these Regulations in your favor. 

This would be controversial and therefore potentially subject to an IRS challenge which you could win or lose, but if this happened to one of my clients and the client felt good about taking some risk, I would pursue this route. Discuss with a good accountant specializing in real estate such as my colleagues contributing to this forum.

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    6y

    Yep, the 3 year deadline is a hard number.  But as an aside, I’m not sure how hard anyone tries to verify your initial move out date.  Yes, you could 1031 it, assuming you set it up, but it’d have to be for an investment property.  I’d rather pay the cap gains than make a bad buy though.

    1Reply
  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    6y

    @Mike H.

    2 out of 5 is a hard rule number.

    You can potentially to a 1031 if this was a rental property for the past 2 year 10 months if you buy another investment property. purchasing a second home won't help.

    maybe also look into a qualified opportunity zone.

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  • Bob B.
    Investor · Jasper GA · Member since 2015 · 1k+ posts · 1k+ votes
    6y

    @Dave Foster will be along in a few minutes to help. 

    2Reply
  • Justin Schmid
    Rental Property Investor · White Bear Lake, MN · Member since 2020 · 4 posts · 1 vote
    6y

    @Mike H. I’m not a tax attorney but I believe you could temporarily move back in (just put a bed in and sleep there. Until you close that way if you go past the Sep. date, you will have homesteaded 2 of the last 5.

    I know its not a perfect situation for a family but might be worth the tax savings.

    1Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Wayne Brooks:

    Yep, the 3 year deadline is a hard number.  But as an aside, I’m not sure how hard anyone tries to verify your initial move out date.  Yes, you could 1031 it, assuming you set it up, but it’d have to be for an investment property.  I’d rather pay the cap gains than make a bad buy though.

    Hey Wayne.  Yep same here.  if it sells in this NYC market i'd be real happy with the problem of paying taxes.  Ya not going to jump on anything.  I have 2 other rental properties that work well and wouldn't want to rush on anything.  Just seeing whats out there. 

    I'm wondering if we rented the vacation property during busy season if that would make it an investment property.  

    0Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Basit Siddiqi:

    @Mike H.

    2 out of 5 is a hard rule number.

    You can potentially to a 1031 if this was a rental property for the past 2 year 10 months if you buy another investment property. purchasing a second home won't help.

    maybe also look into a qualified opportunity zone.

    Thanks Basit.  I doubt it's a qualified opportunity zone.  I don't know what that is though ha.   It was built 15 years ago and has another 10 years of tax abatement. 

    0Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Justin Schmid:

    @Mike H. I’m not a tax attorney but I believe you could temporarily move back in (just put a bed in and sleep there. Until you close that way if you go past the Sep. date, you will have homesteaded 2 of the last 5.

    I know its not a perfect situation for a family but might be worth the tax savings.

    Haha!  very interesting thought.  I don't know i'd have to run that one by the wife.  

    0Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    6y

    @Mike H. The 1031 won’t work if you’re buying the lake home “with family”....you’re selling as an individual, your replacement property in a 1031 has to be titled the same way (in the same name),  no partners.

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6y
    Originally posted by @Mike H.:
    Originally posted by @Justin Schmid:

    @Mike H. I’m not a tax attorney but I believe you could temporarily move back in (just put a bed in and sleep there. Until you close that way if you go past the Sep. date, you will have homesteaded 2 of the last 5.

    Haha!  very interesting thought.  I don't know i'd have to run that one by the wife.   

    No need to run it by wifey. Justin's suggestion is well-intentioned but very counter-productive. It will screw up your eligibility for an exclusion by triggering the nasty "non-qualified use" rule. That little-known rule will force you to pay a portion of capital gain tax even if you could avoid it otherwise. Do NOT move back unless necessary for life reasons.

    However, you actually might have a reprieve from the 9/10 deadline due to Covid. There're IRS Regulations that allow for an exception ("reduced maximum exclusion") under "unforeseen circumstances." While there is no black-and-white safe harbor rule for your circumstances, I have a feeling that we could interpret these Regulations in your favor. 

    This would be controversial and therefore potentially subject to an IRS challenge which you could win or lose, but if this happened to one of my clients and the client felt good about taking some risk, I would pursue this route. Discuss with a good accountant specializing in real estate such as my colleagues contributing to this forum.

    2Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6y
    Originally posted by @Mike H.:
    Originally posted by @Basit Siddiqi:

    maybe also look into a qualified opportunity zone.

    Thanks Basit.  I doubt it's a qualified opportunity zone.  I don't know what that is though ha.   It was built 15 years ago and has another 10 years of tax abatement.  

    OZ refers not to your condo but to what you would do with the proceeds from its sale. If you do not qualify for an exclusion (see my earlier comment) and do not do a 1031 exchange, then your next option is to reinvest the $150k gain into an "opportunity zone" - a new thing that requires specialized knowledge and significant hoops to jump thru and risks to take. Like pretty much anything else that gives you valuable benefits. OZ bring potentially lucrative investment and tax savings opportunities, but they are not for everyone. (Neither are NY, marriage and BiggerPockets)

    2Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Wayne Brooks:

    @Mike H. The 1031 won’t work if you’re buying the lake home “with family”....you’re selling as an individual, your replacement property in a 1031 has to be titled the same way (in the same name),  no partners.

    Got it thanks for clearing that up Wayne !

    0Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Michael Plaks:
    Originally posted by @Mike H.:
    Originally posted by @Justin Schmid:

    @Mike H. I’m not a tax attorney but I believe you could temporarily move back in (just put a bed in and sleep there. Until you close that way if you go past the Sep. date, you will have homesteaded 2 of the last 5.

    Haha!  very interesting thought.  I don't know i'd have to run that one by the wife.   

    No need to run it by wifey. Justin's suggestion is well-intentioned but very counter-productive. It will screw up your eligibility for an exclusion by triggering the nasty "non-qualified use" rule. That little-known rule will force you to pay a portion of capital gain tax even if you could avoid it otherwise. Do NOT move back unless necessary for life reasons.

    However, you actually might have a reprieve from the 9/10 deadline due to Covid. There're IRS Regulations that allow for an exception ("reduced maximum exclusion") under "unforeseen circumstances." While there is no black-and-white safe harbor rule for your circumstances, I have a feeling that we could interpret these Regulations in your favor. 

    This would be controversial and therefore potentially subject to an IRS challenge which you could win or lose, but if this happened to one of my clients and the client felt good about taking some risk, I would pursue this route. Discuss with a good accountant specializing in real estate such as my colleagues contributing to this forum.

    Thanks so much Michael. I was wondering if there would be any leniency as the shutdown affected our ability to get the condo ready for sale and listing.  

    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6y
    Originally posted by @Mike H.:

    I did not promise there would be. I was not even talking about leniency. I said that the existing rules might be interpreted favorably in your case, however the IRS might very well disagree and start a fight.

    0Reply
  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    6y

    One option that has not been throuroughly discussed is to do a §1031 exchange for an investment property that you will convert to your primary residence after two years of rental use..  The §1031 will defer capital gains on the exchange.  After two years of rental use, convert the property to your primary residence.  With this strategy, there will be somecapital gains tax due whenever you sell your primary, but, the taxable gain will be prorated according to length of time rused as a rental vs primary residence.  The longer you occupy as a primary residence, more of your gain can be excluded under §121.

    0Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    @Mike H., You've got some outs here.  It just remains to be seen what plays out.  If you sell before 9/10 you'll get the primary residence exemption and get the first $500K in profit tax free.  If you sell after 9/10 you can do a 1031 and defer all tax on gain and depreciation recapture.  And if the gain is more than $500K and you sell before 9/10 you can actually do both - take the $500K tax free and 1031 the rest.

    The plan for the lake house is summed up in your last sentence - you'd be purchasing solely for personal use and not investment use.  So that would not qualify.  But if you were to buy a lake house to be used for investment and treated it like an investment that would qualify - even if you used it some for personal use.  A short term rental that you use some personally would qualify for 1031.

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  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Dave Foster:

    @Mike H., You've got some outs here.  It just remains to be seen what plays out.  If you sell before 9/10 you'll get the primary residence exemption and get the first $500K in profit tax free.  If you sell after 9/10 you can do a 1031 and defer all tax on gain and depreciation recapture.  And if the gain is more than $500K and you sell before 9/10 you can actually do both - take the $500K tax free and 1031 the rest.

    The plan for the lake house is summed up in your last sentence - you'd be purchasing solely for personal use and not investment use.  So that would not qualify.  But if you were to buy a lake house to be used for investment and treated it like an investment that would qualify - even if you used it some for personal use.  A short term rental that you use some personally would qualify for 1031.

    Thanks so much for the advice Dave!  If we did sell after 9/10.  What do you think of the idea of what someone else mentioned ---- the part in the tax code regarding selling a property and "unforeseen circumstances" ?  Like we couldn't list it til recently and we couldn't get the work done we needed to list it due to COVID19.  Thanks!

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    @Mike H., I'll let the accountants here speak to it but doubt if that would fly.  There is an unforeseen circumstances clause but the IRS isn't much for the "unforeseen circumstances" argument.  Especially in this instance where the argument would be "it was your choice to sell" when you did.  You moved out 3 years ago.  That's going to be a tough case to make.  Something to hope for but not to plan on.  

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  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Dave Foster:

    @Mike H., I'll let the accountants here speak to it but doubt if that would fly.  There is an unforeseen circumstances clause but the IRS isn't much for the "unforeseen circumstances" argument.  Especially in this instance where the argument would be "it was your choice to sell" when you did.  You moved out 3 years ago.  That's going to be a tough case to make.  Something to hope for but not to plan on.  

    Ok true, good points. 

    1Reply
  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    6y

    @Mike H.

    The unforeseen circumstances section of the tax code was intended to apply to those owners who had to sell within their first two years of ownership.  These owners would have been able to meet the two years of ownership and occupancy tests if it were not for unforseen circumstances.  This section of the tax code also provides a pro-rata mechanism for applying a reduced capital gains exclusion to the period of time less than two years of ownership if the sale forced by unforseen circumstances qualifies.  

    1Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Dave Toelkes:

    @Mike H.

    The unforeseen circumstances section of the tax code was intended to apply to those owners who had to sell within their first two years of ownership.  These owners would have been able to meet the two years of ownership and occupancy tests if it were not for unforseen circumstances.  This section of the tax code also provides a pro-rata mechanism for applying a reduced capital gains exclusion to the period of time less than two years of ownership if the sale forced by unforseen circumstances qualifies.  

     Makes sense  Thanks Dave!

    0Reply
  • Dave SpoonerPro Member
    Rental Property Investor · Cincinnati, OH · Member since 2020 · 870 posts · 823 votes
    6y

    @Mike H. Just to piggy back quickly on the Opportunity Zone option - this route takes time, so jump on it ASAP if it's something you want to pursue. You'll need a CPA and a lawyer familiar with setting this up. They'll need to help you create a Qualified Opportunity Fund. You're also limited in where you can invest.

    Opportunity Zones are a great way to defer and even exclude capital gains. They're also a great way to invest back in your community - but they are complicated.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6y

    Not necessarily, Dave. The statutory language "...fails to satisfy the ownership and use requirements described in § 1.121-1(a) and (c)..." can be interpreted broader than the common application you mentioned. I see no mention of the first two years in the Regulations.

    As I mentioned earlier, I would fight for this interpretation for a client of mine, as long as the client accepts the risk of being in unchartered waters.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6y
    Originally posted by @Dave Foster:

    @Mike H., You've got some outs here.  

    Dave, in your usual unmitigated enthusiasm for 1031s, you overlooked this statement from Mike: "our family is considering buying a lakehouse together"
    Someone else pointed out this problem earlier, not sure if Mike paid attention.

    1Reply
  • Mike H.
    OP
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    Originally posted by @Michael Plaks:
    Originally posted by @Dave Foster:

    @Mike H., You've got some outs here.  

    Dave, in your usual unmitigated enthusiasm for 1031s, you overlooked this statement from Mike: "our family is considering buying a lakehouse together"
    Someone else pointed out this problem earlier, not sure if Mike paid attention.

     Yes sir.  Was paying attention.  I don't think the lakehouse would qualify for a 1031.  We don't really plan on renting it out.  And brother, wife, father would all be going in on it.  

    1Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    Well I pointed out the personal use issue.  As far as valuation I just figured it was like your lake house @Michael Plaks, and could easily absorb the reinvestment of the 1031 as well as interests of a dozen relatives.  Speaking of...How are my adoption papers coming along Dad?

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