1031 EXCHANGE FOR SECOND HOME
By: William L. Exeter President/CEO of Exeter 1031 Exchange Services, LLC.
Q: I bought a condo with my parents 20 years ago. We hold title as joint tenant with right of survivorship. The mortgage loan is on me and my parents and we both pay the mortgage. My parents rented out several rooms while they also live in the condo. They stopped the renting about 2 years ago. I have been claiming tax deduction for my share of the mortgage interest on my tax return – (as a second home).
Currently, we are selling this condo and buying another single family house together. The condo has increased in value by about $150,000. Do I owe capital gain tax for my portion? If so, how much? I don’t think my parents have to pay any capital gain tax since it is their primary residence. Will I be able to do a 1031 Exchange in order to defer the capital gain for my share? How do I do the Exchange?
A: The answer is broken down by various questions Currently, we are selling this condo and buying another single family house (not condo) together. The condo has increased in value by about $150,000. Do I owe capital gain tax for my portion? If so, how much?
Yes, you owe capital gains since it is a second home for you. The amount owed depends on what percentage of the property that you own. I’m assuming that by the way you hold title that you and your parents each own a 50% interest, in which case 50% of the gain would be allocated to you. You would have been able to qualify for a 1031 Exchange if it was held, treated and reported as a rental/investment property by you.
I don’t think my parents have to pay any capital gain tax since it is their primary residence.
Correct, the sale of your parent’s home would fall under Section 121 of the Internal Revenue Code (i.e. the 121 Exclusion). They can exclude up to $500,000.00 in capital gain tax free as a married couple since they own and live in the property as their primary residence. The tax free exclusion only applies to their portion of the capital gain.
Will I be able to do a 1031 Exchange in order to defer the capital gain for my share? How do I do the Exchange?
No, because it sounds like the property has been held, treated and reported as a second home. Second homes fall into a category all by themselves and have no real tax benefits upon sale. It all depends on how you treat, report and account for the property.
You might be able to argue that you have held it as investment property, that you treated and reported it as investment property (assuming that you do), but that your parents stopped allowing it to be rented. It does not necessarily have to produce cash flow to be held for investment purposes and to qualify for 1031 Exchange treatment.
However, if it is held merely for a relative to live there, then it would most likely be classified as a second home and not investment property and would not qualify for 1031 Exchange treatment. You should review your specific circumstances with your tax advisor to see if you might qualify for tax-deferred exchange treatment under Section 1031.
William L. Exeter is President/CEO of Exeter 1031 Exchange Services, LLC. He’s been in the fiduciary services industry since 1980, began specializing in real estate tax strategies in 1986 with a specialty emphasis in 1031 and 1033 Exchanges, Self-Directed IRAs, and Land Trusts. Bill has written and lectured extensively on 1031 and 1033 Exchanges, Self-Directed IRAs, and Land Trusts and is a frequent guest expert on San Diego Radio Shows “The Financial Advisors — Money Talk Radio Show” on AM 600 KOGO and on “Inside Business Radio Show” on AM 1000 KCEO. You can email your questions to [email protected], call (866) 393-8370, fax to (866) 393-8371 or mail to 402 West Broadway, Suite 400, San Diego, CA 92101, exeter1031.com. We have Answers; Go Ahead, Ask!