Q: I have a home that was used as my primary residence from April 2002 until December 2006. This December, it will be three years since we’ve been out of our house. We are currently renting it to a family member who is interested in buying it, but having a lot of trouble getting financing. It doesn’t look like they will be able to get a loan by December.
Other than moving back into the house, what options do we have to keep our capital gains exemption, and sell the house to my family member?
A: For some time now, homeowners can exclude from federal income taxes up to $250,000 (if single) or $500,000 (if married and filing jointly) of capital gains from the sale of their primary residence. One additional rule is that the homeowner must have lived in the home as their primary residence for two out of the last five years.
One way for you to sell your real estate if the buyer can’t get conventional financing is to offer the buyer seller financing or sell the home on an installment basis. By using an installment sale you would qualify for the benefits of the tax exclusion but you would take the risk of being your buyer’s lender – something that might not be comfortable.
You should also consider how much money is involved. Is the amount of capital gains from the sale going to be large? As a result of recent housing price declines, your profit (capital gains) on the sale of your real estate might be less than you think. You should sit down and compute what your profit will be if you sold while you would still qualify for the home sale tax exclusion. Then you should determine what your taxes would be if you sold the home and you did not qualify for the home sale tax exclusion. For many, the maximum capital gains tax is fifteen percent even on the sale of real estate.
If after you compute the capital gains taxes and other taxes you might have to pay from the sale of the real estate, if you don’t sell within the time period that would allow you to qualify for the exclusion, and you won’t sell the home on an installment basis or provide the buyer with seller financing, your options to preserve your tax status might be quite limited.
If your gain is large from the sale of the real estate, you would be wise to sit down with a good accountant to go over all of the aspects of your home ownership to see if there are any other tax rules could help your situation. Please note that if you have taken depreciation for the property over the past three years that it has been a rental, you might need to “recapture” that depreciation. You should chat with your tax advisor or accountant for more details.
If the home is no longer eligible for the home sale exclusion and you were planning on using the money to invest in an investment property, you might benefit from a 1031 tax deferred exchange of real estate. In a 1031 exchange, you would sell the home and buy a like-kind real estate property. The 1031 exchange, also called a tax deferred exchange or Starker trust, would allow you to defer paying all taxes, including recapture taxes on any depreciation you took, until the replacement property is sold and you would also not have to pay any taxes on the capital gains. In some cases, you might not have to pay taxes at all (federal or state).
What is a 1031 Exchange? Video
But you’ll need to be careful. The 1031 exchange (real estate tax deferred exchange or Starker Trust) rules are rather specific and can be complicated. Do yourself a favor and talk to a professional in the area of 1031 exchanges (tax deferred exchanges or Starker Trusts) for more information.
Find more information here about the risks associated with seller financing and how to qualify for a capital gains tax exemption
We have a number of videos relating to 1031 exchanges for you to view including the following:
What is Cost Basis for Purposes of a 1031 Exchange? Video
What to Ask a 1031 Exchange Company? Video
How would you go about reporting your sold home with seller financing and using the homeowner capital gains exemption? We can’t get a straight answer from anyone on this? Do we still claim the interest on the mortgage we have? Do we report the sell of the home, do we just do a 1099 int with the buyer?