{"id":820,"date":"2015-03-12T10:09:04","date_gmt":"2015-03-12T17:09:04","guid":{"rendered":"https:\/\/shellyrobersonrealtor.com\/?p=820"},"modified":"2015-03-25T21:51:10","modified_gmt":"2015-03-26T04:51:10","slug":"irc-1031-121-powerful-combo","status":"publish","type":"post","link":"https:\/\/shellyrobersonrealtor.com\/irc-1031-121-powerful-combo\/","title":{"rendered":"Attention Downsizing Baby Boomers \u2013 Sell Your House, Protect All Your Equity, and Pay NO Capital Gains Taxes with this Simple Strategy Using Tools Congress Gave Us"},"content":{"rendered":"

Many of my parent\u2019s friends who have fortunately accumulated significant equity in their homes over the last several decades are faced with a dilemma of downsizing into a smaller home because they can no longer conveniently or adequately take care of their properties.\u00a0 Importantly, many of them desire a simpler-smaller property, usually all single-level, accessible and easy to maintain.\u00a0 The problem exists because if they sell their home with substantial equity they face significant capital gains exposure even with the IRC Section 121 exclusion in place.<\/p>\n

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For example, a married couple may exclude from capital gains tax $500,000 (Sec. 121) if they have resided in their primary residence two (2) out of the last five (5) years.\u00a0 So, if a couple has accumulated $2,000,000 in equity in their home (after improvements and original purchase price) they would still have a $1,500,000 capital gain.\u00a0 In California, with all of the taxes included, the capital gains rate is approximately 33% (highest in U.S.).\u00a0 Thus, this couple would have to pay approximately $495,000 in capital gains taxes in the next tax year after their sale.\u00a0 So how do we get around this challenge?<\/p>\n

Congress Is On Your Side Sometimes \u2013 Believe It or Not\"AA<\/a><\/h2>\n

With the Congressional enactment of the American Jobs Creation Act of 2004 and the Housing and Economic Recovery Act of 2008, and Department of the Treasury Revenue Procedure 2008-16 the government has made it easier for homeowners to keep more of their equity \u2013 and even not pay any capital gains taxes, ever \u2013 if they don\u2019t want to.<\/p>\n

Internal Revenue Code Section 121 (The \u201c121 Exclusion\u201d)<\/h2>\n

This code section says that if a property is your primary residence and you (or you and your spouse) have lived in it for two (2) out of the last five (5) years you can sell the property and exclude from taxes $250,000 if you are single, or $500,000 if you are married and file a joint tax return.\u00a0 This code does not apply to second homes, vacation homes, rental homes, or investment properties.\u00a0 Another wrinkle is that you can only exclude capital gains and not recaptured depreciation (but that is another article).<\/p>\n

\"AA<\/a>Internal Revenue Code Section 1031 (The \u201c1031 Exchange\u201d)<\/h2>\n

A 1031 exchange allows a person to sell a property (\u201crelinquished property\u201d) that was held as a rental or investment property and then exchange the proceeds from that sale into a new \u201clike-kind\u201d property (\u201creplacement property\u201d) also to be held as a rental or investment property.\u00a0 The benefit of using a 1031 exchange is that no matter what capital gains you may have accumulated in the \u201crelinquished\u201d property they are all transferred into the \u201creplacement\u201d property and no taxes are due or payable at that time. The taxes are deferred into the replacement property.\u00a0 The 1031 exchange does not apply to a primary residence, but you can convert your primary residence into a rental property and take advantage of all its benefits.<\/p>\n

Combining IRC Section 121 and IRC Section 1031 Is Powerful<\/h2>\n

Over the 239 years or so that this country has existed there has never been one set of laws that allowed more American families to accumulate more wealth than Section 1031.\u00a0 Mind-boggling multi-generational wealth has been created by clever investors who never pay capital gains taxes on their real estate portfolios even though they keep selling and buying more and more and bigger and bigger buildings.<\/p>\n

With careful and meticulous tax planning people can combine both IRC 121 and 1031 to legally avoid and\/or defer all capital gains taxes on the sales of real property \u2013 while improving the assets by buying bigger and better buildings each time one is sold.<\/p>\n

Three Different Methods of Converting Properties for this Strategy\"AA<\/a><\/h2>\n

There are three (3) distinct transactions which these two code sections will allow sellers\/investors to take full advantage of the code.<\/p>\n