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Shawn A. Goldfaden, Esq.
Division Manager for Asset Preservation, Inc.
Maryland State Counsel for Stewart Title Guaranty Company
Although IRC Sec. 121 permits taxpayers to exclude up to
$250,000 if single and $500,000 if married filing jointly of the
capital gain on the sale of the taxpayers primary residence if
at least one of the homeowners has used the property as their
primary residence for 24 out of the last 60 months, homeowners
are increasingly seeing proceeds from sales in excess of such
exemption. As such, homeowners must look for ways to defer the
tax on gain. One method of accomplishing this goal would be for
the taxpayer to establish a new primary residence, convert the
existing property into an investment opportunity and hold on to
it for the requisite period before utilizing a §1031 exchange
(most tax advisors believe that renting the property for one or
two years is sufficient). Once the one or two year rental term
expires, the taxpayer can segregate their tax liability by using
IRC §121 and §1031 to exclude the first $250,000 or $500,000 and
defer taxes on the remainder of the proceeds by using the excess
proceeds in a §1031 exchange transaction (ex.: home bought for
$500,000, sold for $2 million, §121 exclusion on $500,000 and
§1031 deferral on remaining $1 million). Of course the couple
will have to follow the required rules of §1031 exchanges in
order for them to leverage their capital gain tax deferral,
substituting their property with a “like-kind” asset which will
hopefully be worth considerably more than the tax on their gain.
Another opportunity exists for those taxpayers who own property
as a home and as a business proportionately appurtenant. For
instance, a duplex in which the owner resides in one section of
the property, by rents out the remainder or uses that portion as
a home office may qualify for a segregated §1031 exchange. IRS
private letter ruling 2005-14 makes it clear that the exchange
of a home can qualify for both the Code §121 home sale exclusion
and Code §1031 like-kind exchange deferral. This can occur where
the property was used as a principal residence and a business
consecutively (e.g., use as a principal residence followed by
rental of the property) or concurrently (a portion of the home
used as a principal residence and a portion used as a home
office). Make sure your clients understand that an accountant is
generally needed to determine the value allocated to the
residence portion and to the remaining units held for
investment. A tax professional may use factors such as the
square footage or the quality and value of improvements to each
unit in determining what percentage is considered the primary
residence and what percentage is allocated to the exchange
portion. [Note: Proper closing techniques must also be applied.
Caveat: Private letter rulings are based upon very specific
scenarios and are not to be interpreted or applied broadly.
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