How can I avoid paying capital gains tax on my live-in flip?

Question

Hey Everyone!

I bought an old beat up house just outside of Louisville, KY in August 2019 for $120,000 with the intentions of fixing it up while living there as I am just out of college and was looking for a place to live. Once it's done the house should sell for around $240,000. I want to make sure I am making the right decisions now in order to protect myself from having a decent tax bill.

My plan with the house originally was to renovate it over the course of two years and than sell it to avoid paying any capital gains tax.  About 6 months ago I realized I would probably have the house done much sooner than I had planned so I met with some realtors to talk about my options with selling it before meeting the two year threshold of ownership.  One of the realtors I met with suggested that I could do a 1031 exchange to avoid paying any capital gains tax on it despite only living in the home for just over a year.  Upon further research, I believe I have discovered thats incorrect and I wouldn't meet the requirements for a 1031 since its technically my "primary residence" and not an "investment property".

My question is this:

What is the best way for me (if possible) to wrap up this house in the next few months, sell it, and avoid paying capital gains tax?  As stated earlier, I purchased it in August if 2019 and will have it ready to sell by the end of March.  Would waiting until the end of this August (2021) to sell the house be my best option?

Any input or advice would be greatly appreciated!

Jesse

Zander Kempf · Answer

It sounds like it's worth the wait. Additionally, you can still list it on the market and just advertise that you can't close before X date. As long as it's not more than a couple months out then it shouldn't be a problem. You usually don't close for a month or so anyways with someone getting a loan.

Another option would be to sell it and have someone go under contract with you, but move in now and start paying rent. Then you get some income and the property locked up under contract. As long as the contract spells everything out clearly and you collect a hefty down payment then that may be a viable option.

Waylon Zook · Answer

@Bob Norton

Thanks for clarifying....its interesting how what would seem to be the same thing works different.

Bob Norton · Answer

@Jesse Stemle Wait until August 2021 to get the tax free money, then repeat that with your next purchase.

@Waylon Zook To qualify for long-term capital gains, you need to hold a property for one year and one day.  To meet the two year gain exclusion for your primary residence, you need to wait two years plus one day.

Wayne Brooks · Answer

Yes, yes, yes....no other way.

Basit Siddiqi · Answer

@Jesse StemleI normally tell people to do the calculations of tax dependent on the different scenariosScenario 1 - Wait till the 2 year mark = pay $0 taxScenario 2 - Sell now and have a $120,000 gain which would result in about $24,000 of Federal and State taxes.Scenario 3 - ???

Evan Polaski · Answer

@Jesse Stemle, what are your carrying costs? What are your uses for the money once you sell? How much are you in the house TOTAL (purchase, closing costs, rehab costs, interest, property taxes etc)?

Is there a way to avoid paying capital gains?  Yes, you don't report it, but that would be tax fraud, so I don't recommend it.

Sitting on the house for another 5 months is probably your best bet, especially if you don't have another place to invest your capital.  But if you are going to miss out on another flip that will make you more than the 20% you will owe in taxes, then you would typically be ahead by selling and reinvesting into your next flip.

And you are right, you cannot 1031 your primary and you cannot 1031 a flip.

Waylon Zook · Answer

@Jesse Stemle

Wait the few extra months until august and enjoy the results of the hard work you put into it and recharge your batteries.

Also list one month prior to two year mark so you are ready for closing at right time.

Have you double checked with a cpa...i have heard one year and one day count as two when it comes to short term versus long term. Not sure if primary residence would work the same way.

Wayne Brooks · Answer

@Todd Drake As this is his Primary residence, he will pay No tax, after 2 years...section 121.

Todd Drake · Answer

Long term capital gains result from selling assets owned for more than 1 year, not 2. Anything sold before 12 months is taxed as regular income.

Or am I missing something?

Jesse Stemle · Answer

@evanpolaski ,  My carrying costs on the house are just about $1,000/mo however it is currently my primary residence.  Once the house is finished at the end of March, I will be all in at around $155,000. The property needed substantial work but I was able todo just about all of it myself which is the reason for such low rehab costs (This does not factor in the value of my time).

After selling this house, I plan on using the profits to purchase two properties.  One as another live-in flip similar to what I am doing now and the other as a SF rental house.

After hearing your advice and talking with a few other people, I feel like my best bet at this point is to just hold out for the 5 months and list the house at the end of August. I just wasn't sure if I had any other options.

I appreciate your input!

How can I avoid paying capital gains tax on my live-in flip?

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