Pay In Full
I am in a situation where I can sell a 1br/1ba condo and pocket about $100K. I plan on reinvesting this money but have a couple questions.
1. Even with the 1031, do I have to pay regular income tax on that money?
2. What are the tax implications on fully paying off two or three other multi-unit properties with that money. i.e. is it smart to completely pay them off and have to pay full taxes on all of the rent (-depreciation)
Thank you for all of your advise. My goal is to be able to give some on here one day. I do plan on keeping everyone abreast of doings and lessons learned.
Hello.
Question:
Is this condo your primary residence or has it been a rental?
It is a rental. I have another primary.
Quote:1. Even with the 1031, do I have to pay regular income tax on that money?If you do a properly structured 1031, you will reinvest all that money in your replacement property. Capital gains taxes are deferred on all the exchange funds that you reinvest in your replacement property.
Put any of the money in your pocket, instead of your replacement property, and that money is taxable.
Quote:2. What are the tax implications on fully paying off two or three other multi-unit properties with that money. i.e. is it smart to completely pay them off and have to pay full taxes on all of the rent (-depreciation)Whether it is smart to own your investment property free and clear depends upon you and your values. If you are in or nearing retirement and need the cash flow for your lifestyle needs, then it may be a good thing to do.
If you are younger, still employed, and support your lifestyle needs with just your salary, then why pay off those mortgages and quit letting your money work for you. One of the greatest advantages of real estate investing is the power of leverage gained from using other people's money. Put $20K down on a $100K property, then watch the property double in value in ten years. Your $20K "investment" earned $100K in 10 years -- a 1000% return. Own the same property free and clear, your $100K investment will only double in ten years.
The other half of your question asked what the tax implications would be if you used the proceeds from the sale of your rental property to pay off the mortgages on other investment rentals. The sale of your rental property will be a taxable event. You will pay capital gains and depreciation taken since 1997 will be recaptured. The sale proceeds are taxable regardless of what you do with the money.
Thanks for all of your help (on all my posts) We are in a situation where I think we will need that full cash flow for about two years while we are settling from a coast to coast move and one of us is not working while having another kid. With all of the knowledge you have given us, I believe we are going to just pay off two rentals and use the cash flow for the first two years. THEN, take the money out of those units to buy more. Does that make sense?
Do I understand that the 1031 exchange is not a "sale"? Am I getting my terminolgy mixed up?
Well, newkid. I am learning more and more. I understand that a 1031 is very complicated. I am still reading up on it. I understand the Sale actually goes to an "qualified escrow account or mediator" (Do you have a preference?) I also saw something that said there was no clear description of a length of time that constituted intent as for it being an investment property. I saw a guideline of over 2 years though before it can be used as a primary residence. I also read that the law has changed and you must live in a place for 5 years (vice 2) in order for it to be clear of capitol gains now. I'll keep reading. What is the going rate for processing a 1031? I am finding about $600 + additional properties.
Bill Exeter is a frequent contributor to this site and is a professional exchange facilitator. His all inclusive fee is about $750. Send Bill (wexeter) a PM or visit the website in his profile.
In a deferred 1031 exchange, you sell your relinquished property and purchase replacement property with the assistance of a qualified intermediary. However, for tax purposes, you do not have a sale and purchase -- you have an exchange.
Understand that if you follow your plan of using the sale proceeds from your rental property to pay off mortgages on other rental property you own, then you have a taxable sale. A 1031 exchange will not work for you here.
The 5 year rule you refer to only applies to property acquired in a 1031 exchange then later converted to your primary residence. If you did not initially acquire your primary residence in an exchange, then the two year rules apply. [ Edited by NewKidinTown2 on Date 01/03/2005 ]
Thank you so much Newkid. I am going to contact Bill.
Once last clarification:
If I have lived in my rental property 2 of the last 5 years, Can I sell it and not incur taxes?
On top of that, can I also, in the same year, sell my primary residence which I have owned for two years, without incurring taxes as well? As long as they don't add up to $250K/$500K?
You can do either but not both. The capital gains exclusion may only be taken on one property and only once in a 24 month period.
Sell your rental, take the capital gains exclusion this year while you are still in the 2 of 5 year primary residence window. Convert your current primary into a rental for two years, then sell it tax free. As long as the two property sales are more than 24 months apart, you will be OK.
The capital gains exclusion applies on UP TO $250K in profit (per taxpayer) on a single property sale. Any portion of the capital gains exclusion not used is forfeited.
The capital gains exclusion is optional. You are not required to take it. If your rental property will only have a $25K gain, while your current primary residence will have a $100K gain, AND you plan to sell both properties within the next year. Pay the taxes on the sale of your rental property and apply the capital gains exclusion to your current primary residence.