Subdivide Property And Use 1031 Tax-Free Exchange

Q: We own approximately 12 acres of land. We would like to sell part of it and need to know what we can do with the profits from the sale. Can we roll it into our current mortgage or can we buy an investment property or vacation home?
 

The mortgage is for the house we built on the land four and a half years ago. The part of our property that we would want to sell has a separate, smaller house, barn and storage building on it.

We think we have found a buyer, but we don't want to be taxed heavily on the profit if we did sell. Thank you for any advice you can give us!

A: Your letter is a bit confusing, but it sounds like you like you own 12 acres of land and you actually live in a house that is located on the property. You're now looking to subdivide the land and keep the profits without tax on the sale.

When you subdivide property, your property will be treated as two parcels. If you live on the part of the land you are selling, then you are selling your primary residence and would be allowed to keep up to $250,000 (or up to $500,000 if you're married) in profits from the sale tax-free. You could then move onto the parcel of land that you're keeping and make that your primary residence.

If, however, you are selling a parcel of land that you do not live on, then it is treated as investment property. If you would like to defer taxes on the sale of this property, then you must turn around and purchase a different investment property for at least the same price as the property you are selling.

This is called a like-kind exchange, which is also known as a 1031 tax-free exchange.

To properly execute a 1031 tax-free exchange, you will need to meet certain deadlines and have a third party intermediary hold the cash in an escrow account while you are finding a replacement property.

If you simply sell the property, you will pay long-term capital gains on the sale, which could be as much as 15 percent capital gains plus whatever your state charges for capital gains tax.

First things first. You'll need the services of an excellent real estate attorney who can work with you to properly subdivide the property and make sure the documentation is correctly prepared so that there are no problems down the line from the sale.

If you decide to do a 1031 tax-free exchange, you'll want to work with your attorney and tax-preparer to make sure you meet all of your deadlines. You may also want to sit down with a good accountant to review all of your particular circumstances and make sure that the division of the land and its sale benefits you in the way you want.

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