Q: We own a 22-acre property that is set up for horses in Cedar Rapids, Iowa. The property is in a very hot location.
The house is 35 years old and is in need of some repairs. The property is roughly in the shape of a “U” and we would like to build a retirement home and small barn on the other side of the “U” opposite from where the current house sits. Once we do this, we could either rent or sell the other portion of the property.
Financially, we’d need to at least break even, and that’s after we had built the new house and barn. We may be facing early retirement or disability and do not wish to dip into our modest nest egg any more than absolutely necessary. We are in our early 50s and hope to keep our horses at least another 10 years.
If we sell one-half of the property, we’re concerned about losing control. We would like to keep developers off our land and maintain the rural atmosphere we enjoy.
On the other hand, dealing with renters and being responsible for the repair and upkeep of the property is unappealing both financially and physically.
We haven’t had an appraisal of the existing property, but it wouldn’t surprise us if our property were worth in excess of $500,000. Our profits would be around $150,000. What kind of capital gains taxes would we face if we sell?
What should we do?
A: Living on a 22-acre property with horses sounds peaceful and beautiful. I can see why you’d like to keep the land out of the hands of developers. There are ways to do that, although it may cost you some of the value of the land. More on this in a moment.
Let’s first address your future retirement needs. If your property is located in a “hot” area, chances are it will only become more valuable as the area becomes more developed. While you may not want your property cut up into half-acre lots, developers are your friends since they will continue to develop and sell the surrounding area, making your property’s future value grow.
How much will it grow? If your property is conservatively worth $500,000 today, it could be worth double or triple that in ten years – or a whole lot more.
Which is a nice amount of cash to have in your pocket once you tire of your horses and decide to move. In fact, I think it may be too good to pass up.
But how do you make it work right now?
In order to have the cash to build your new home, you can refinance your property and take out a new mortgage, or use a home equity loan. You can use some of the funds to improve your existing house and then rent it out. When you rent it out, you can ask for two months’ rent as a security deposit, and require the renters to keep up with the maintenance of the property.
Ideally, you’ll be able to rent out the property for enough cash to cover the cost of the mortgage or home equity loan. If you’re unsure of how much you could get in rent, you might want to check around with several real estate agents who rent property.
Let’s address your capital gains question next. If you sell now, and have a $150,000 profit, you would owe nothing in capital gains. As long as you have lived in the property as your primary residence for 2 of the past 5 years, you can keep up to $250,000 (up to $500,000 if you’re married) in profits tax free.
I have no idea what the tax laws will say 10 or 20 years from now, but assuming they stay the same, you would keep up to $250,000 (or up to $500,000 if you’re married) in profits tax free, and then pay capital gains tax of up to 15 percent on any profit that exceeds that amount.
However, if you are renting out part of the property, you may be able to consider that portion of the property an investment property, and defer any capital gains tax you’d owe by exchanging that portion of the property for a different investment property. This nifty little tax maneuver is called a 1031 tax-free exchange. It’s also known as a Starker Trust. Your real estate attorney or tax advisor can help you further with the tax advantages of owning investment property.
Finally, I can tell you’re concerned that your field of dreams will turn into the next hot subdivision. There are ways to prevent this from happening.
For example, you can subdivide the land so that your new little house and barn sit on just an acre or two of land. The other twenty acres can then be sold with the stipulation that it remain as “open space” in perpetuity.
Groups that may be interested in purchasing your land to preserve the open space include a local land conservation group, your local town or village, the local forest preserve or park district. When you sell, you should stipulate in writing in the contract that the land is to remain as open space forever. Your attorney would assist you in making sure your stipulation can be enforced in the future.
While you may not get as much money as if you sold to a commercial developer, you will sleep easy knowing that the land from which you received so much enjoyment will remain there for others to enjoy as well.