Q:

Subject: Please help me undertand:

 

OK – My Personal Residence is worth 2.5 Mil.

My Wife & I moved in 10 yrs. ago but it was purchased out of proceeds from a couple 1031 roll-overs started in 1985 and that original purchase was $85,000.00

I want to sell and buy a lesser personal residence priced at 2.0 Mil. Can I take the $500,000.00 and put in my pocket with no further tax consequence or do I get hammered for $ Two Million worth of profit.

Thank you,

A:

 There hasn’t been a residence replacement requirement since 1997, so what you do with the sales proceeds will have no effect on your tax bite.  You can see the current rules here.

If you sell the home as your primary residence, your gain will be approximately $2,415,000 assuming your cost basis is that $85,000 figure.  It will obviously be lowered by any capital improvements you have put into it and any selling costs.  It will be increased by depreciation while it or its predecessors were used for business or rental. 

You and your wife are eligible for $500,000 of tax free gain.  This means the remaining $1,915,000 will be taxable.  Except for the depreciation recapture portion, it will be taxed as long term capital gain. 

For that kind of money, you should be consulting with a tax pro.  There are a number of ways to reduce the tax hit, including recognizing any capital losses that you may have in your portfolio.  A more aggressive tax saving technique would be to convert the home to rental and then do a 1031 exchange with it

Good luck.

Kerry Kerstetter

 

Follow-Up Q:

Thank you for your reply, after my E to you I found another article, and with all due respect I have enclosed a link that states the opposite.

As I read it, the example is exactly my scenario.

Two thirds down the article please see “IS THE REVERSE TRUE”

It states I believe that when the property status is changed from a 1031 Income to a Personal Res. that the gain is deferred and the cost basis begins then. (We moved in 1994)

AM I WRONG??

http://www.1stgrand.com/Understanding_Capital_Gains_Tax.htm

A:

Actually, you are seriously misinterpreting the rules here.

Converting a home from rental to personal, or vice versa, is not a taxable event and thus does not change its cost basis.  It remains the same.

That section called “Is The Reverse True” really deals with the pre May 1997 rules for residence replacement and is no longer relevant. 

You really need to be working one on one with a tax pro on this.

Good luck.

Kerry Kerstetter

Q:

Subject: nother sextuin 179 question

 

This is one of those questions that almost afraid to ask because the answer seems so simple that I must be missing something REALLYobvious. However, I havent been able to find a definate answer or anytthing suggestive. Ive spent 2 or 3 hours searching for some kind of answer with no luck, so here it is-

 

Is the section 179 only good for two items which space is provided for on the form? Is there an item number limit for this deduction?

 

Thanks for your time.

A:

I have seen plenty of people, including some tax pros, with the mistaken belief that the number of blank lines on an IRS form dictates how many items can be listed.  That is absolutely not the case.  Whenever you have more items than blank lines available, enter “See Attached” and have a detailed listing.  This is done automatically by most tax prep software.

For Section 179, there is no numeric limit to the number of new business assets for which it can be claimed on each year’s tax return.  All that matters are the dollar values.  I have prepared returns where we had two and three full pages of small dollar items listed, totaling up to the maximum available, or even lower.

Good luck.

Kerry Kerstetter

Q:

Subject: Converting property acquired through a 1031 exchange to primary residence

 I have a rental property that I acquired through a 1031 exchange and would eventually like to move into it and make it my primary residence.  The exchange took place in July 2004 and the home is presently rented for a year.  Is there a specific period that you have to wait before we can make the conversion?  Do you know of any IRS tax case law or hearing decisions regarding these types of conversions?

A:

 There is no statutory length of time required before converting a rental home to personal use.  Obviously, the longer, the better because real life events go a long way in proving intentions.

There is now a five year waiting period for a home acquired via a 1031 exchange to be eligible for the Section 121 tax free gain of up to $250,000 per person.

What is most important in regard to a conversion from a rental to personal use is that this not be pre-planned at the time of the 1031.  The idea of making the conversion must arise after the new property has been used for the rental or business purposes that qualify it as suitable replacement property for the previously owned property.  If IRS were to learn that your intention at the time of acquiring the new property was to live in it yourself, they have the power to nullify the 1031 exchange and force you to pay the taxes on the original sales, plus penalties and interest.

Not that people don’t plan these kinds of things out ahead of time.  The smart ones keep such plans to themselves and make sure all documents and witnesses can verify that any conversion plan arose well after taking title to the new property.  The stupid people shoot their mouths off about the plan, telling everyone of their intentions, and end up in deep doo-doo as a result. 

I hope this helps.

Kerry Kerstetter