 Dying
to sell home, avoid capital gains taxes
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 Dear
Tax Talk,
I purchased my current primary residence in October 2004 (about
10 months ago) and am dying to sell it so I can move to a better
area. However, I know that in order to avoid capital gains tax on
the approximate $200,000 appreciation on my house, I would need
to have lived there two out of the last five years. Are there any
loopholes that you know of that will allow me to classify the property
as an investment property and use the 1031 exchange code?
One wild idea that I have is this (but not sure if
this will work or if it is legal per tax codes):
Move out of my house. Put my house on the market and
have a condition in the sales contract that the buyers would need
to "rent" from me for one to two months before actual
closing of the sale transaction. Or, I can have a contract in addition
to the sales contract that details this rental agreement so that
none of the rental agreements are on the sales contract. In the
meantime, I would live in a rental property and purchase a new house
after the closing of my existing property. Can I claim that my property
is an "investment property," since I had rented it out
for one to two months prior to its sale?
Another question that I had was, let's say that I
have successfully completed a 1031 exchange:
1. Am I allowed to move in right away and use the
acquired property as my primary residence (since technically, it
is supposed to be an investment property)?
2. If I live in the acquired property for two years,
then do I get the $250,000 single/$500,000 couple exemption on the
capital gains? If so, does the exemption apply to the entire gain
from the acquired property? What about the gains from the initial
property on which I had done a 1031 exchange? Isn't that supposed
to be deferred taxes only?
Thank you so much for your advice! -- Sylvia
 Dear
Sylvia,
Thanks for writing most of today's column, though
I'm not sure all your efforts will pay off. However, apparently
living in the bad area paid off in home appreciation.
As you state in point No. 1, you can't move into the
acquired residence since the replacement property has to be for
investment purposes and cannot be a personal residence. In addition,
I don't see the one- to two-month rental period as qualifying the
property as investment property.
If you were able to get the Section 1031 exchange
successfully completed, there is a new rule that increases your
time limits to get the principal residence exclusion that you discuss
in your second point. Under this new rule, you cannot get the gain
exclusion for five years following the purchase of the like-kind
property. Also, keep in mind that you could not use the like property
as your residence right away since then it wouldn't qualify as investment
property. After the five years are up, the deferred gain from the
first exchanged property would qualify for the $250,000 or $500,000
exclusion as appropriate.
Your best bet would be to try to get a partial exclusion
under the exception for health reasons or unforeseen circumstances.
See IRS
Publication 523 for a discussion of these exceptions.
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