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How can we minimize capital gains taxes when selling rental property?

If my wife and I sold a rental property for $150,000 and purchased a new property for $300,000, how would we avoid capital gains taxes? I am aware of the 1031 exchange option, but we want the new property to be our primary residence. Could we rent it for a period of time before living in it? How long?

Real Estate, Taxes
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July 2018

The only way to avoid capital gains treatment on a real estate rental / investment property sale is by doing a 1031 exchange.  The exchange avoids immediate taxation but technically just “defers” it down the road.

Exchanging a rental into your primary residence is a prohibited transaction.  You can’t 1031 exchange into any personal or related personal use assets.

Some people exchange one rental for another and then convert that rental down the road into personal use and that is ok.  There is no true bright line test or rule to this.  At minimum, you should have at least two years’ worth of tax returns showing the replacement property was placed into service as a rental in my opinion.

Also realize that “intent” is an important element.  According to Jack Hackett at Farr Law, he says, “The replacement property must be owned for at least 24 months immediately after the exchange (the qualifying period) and in each of the two 12-month periods in the qualifying period: (1) the taxpayer must rent the replacement property to another person at a fair rental for 14 days or more; and (2) the taxpayer’s personal use of the replacement property must not exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rented at fair rental.  It can be rented to a family member as a principal residence so long as market rent is paid.”

The longer you rent it, the safer the conversion to personal use.  The shorter the period, the more it can be questioned and if you lose, you owe all the taxes on the transaction.  Make sure your CPA signs off on this transaction and your actions.

July 2018
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