Change In Life Plan Will Entail Large IRS Bill

Q: My husband and I own 14 properties and one primary residence.
 

My husband would like to go into full time ministry work and we would like to sell some of our properties to give us some cash to live on.

We figure we could sell 11 properties and use the profits to pay off the mortgages of all our 14 properties and our primary residence.

We’d live on the passive income from the remaining three rental properties, which would cover all of the expenses plus would pay the expenses for our primary residence.

Since we are using the profits to buy our primary residence and since my husband would no longer have any income, would we still have to pay capital gain taxes?

Is there any way to avoid paying capital gains taxes so that we could direct all the money toward paying off our mortgages?

A: Although your husband would like to go full-time into the ministry, that doesn't erase what you and he have been doing (quite well, I might add) with your financial lives up until this point -- at least as far as the IRS is concerned.

It appears to me you've confused several issues, so let's try to sort them out one by one.

First, when you sell your rental properties, you will not only owe capital gains tax on the sale, but if you have been depreciating those properties you will also have to recapture the depreciation for the IRS.

The only way to avoid paying capital gains tax would be to set up a 1031 tax-free exchange (also known as a Starker Trust) but you would have to buy a replacement investment property with the proceeds. It’s clear to me that you're no longer interested in developing that side of the business.

Once you've paid whatever taxes you owe, whatever is left could be used to pay down (or off) the remaining mortgages on your properties.

And that includes your primary residence, which you are not "buying" as you mistakenly suggest in your letter. You already own it. What you are doing is simply paying off the mortgage so you own it free and clear.

Since you're trying to unload so many assets and simplify your financial life, you need to sit down with an excellent accountant who can help you strategize what would be the best way to sell the properties to take advantage of whatever tax benefits are available to you.

For example, it may be in your best interest to sell a couple of houses a year over the next few years, especially if your husband doesn't anticipate having any income. Or, it may be better tax-wise to sell everything in 2005 and bite the bullet on taxes.

I haven't seen your numbers, which is why it's best to sit down with an accountant who can help you use what you have so impressively built, in the best way possible.

NOTE: This column is distributed by Real Estate Matters Syndicate, PO Box 366, Glencoe, Illinois, 60022. This column may not be resold, reprinted, resyndicated or redistributed without written permission from the publisher.