So you’ve made the decision, it’s time to sell an investment property. You want to pull your trapped equity to reinvest in other opportunities. What is your net profit going to look like these days? Today we will look at various rates and tools for the 2014 tax year. (As a discussion, this is not a solicitation of tax advice.)
While this can become a complicated subject, we will stick to a basic example through the discussion: our client is single, with one home that was not originally purchased as an investment. However, it has been a rental for three of the last four years. What options are available to someone in this scenario? In seeking information, our client in this example wants to maximize his return and minimize his tax liability.
A 1031 Exchange is out of the question because he is not interested in maintaining an investment property any longer. This vehicle works to defer gains as long as proceeds are invested in “like” property. A cottage industry exists in defining “like for like” changes to fall within the rules of an exchange, and this can get sticky for those looking to push the envelope with this tax vehicle. You wouldn’t think off the top of your head that someone could roll equity from a vacation home into, say a helicopter. But that “like for like” depends on the initial use by those pushing the legal bounds. We have tried to follow the logic used, but by attempting to say the vacation home was a recreational vehicle somehow bridges the gap to a helicopter… If an RV can be a second home, why can’t a vacation home be a “recreational vehicle?” While this argument is as strained as traffic at the 5/805 merge, it continues: since the helicopter in question would be used as a recreational vehicle, it only makes sense that “the home be an equivalent use.” Hope these people have a good tax attorney!
A more likely outcome is to look at the legal use of a “primary” residence regarding capital gain tax. A quick look at 26 U.S. Code § 121 – Exclusion of gain from sale of principal residence says:
“(a) Exclusion Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.”
As you can see from our example, options are available with careful planning and timing. As the saying goes, only two things in life are guaranteed: death and taxes. At least the tax code has some wiggle room!