Selling former primary residence to avoid capital gains taxes

[jfoxcpacfp]

I think you need to get clarification from a CPA about this as the ownership wasn't just by you and your wife while you were living in it. Did you pay rent to your buddy? Is it owned by an LLC or a legal partnership?

I agree with the comments about selling, but dennis makes the point I initially thought of (but you got to it first, so you get that point ): This isn’t just about you selling - you have a partner. I would expect him to be given first right of refusal. After all, this will cost him taxes, not you (except for depreciation recapture taxed at a top rate of 25%, don’t forget). So it might be in his best interests to buy you out and live in the place for a couple of years while it (hopefully) continues appreciating. If it doesn’t, at least he made decent money off the deal, too, which is a lot better than a sharp stick in the eye.

Advice for him, though - if he wouldn’t turn around and buy this house over any other property he could find for this money, he, too, should consider pocketing the gains.

Assumed masculine due to use of “best buddy” - cannot say I would call any girlfriend that when referring to her, but I may be wrong!

[dennis]

I think you need to get clarification from a CPA about this as the ownership wasn't just by you and your wife while you were living in it. Did you pay rent to your buddy? Is it owned by an LLC or a legal partnership?

[robinhalldunn]

Thanks everyone for the input and the help! Much appreciated!

[StarTrekDoc]

You have debts to retire that this could help nicely. The benefit is now to retire that debt while having the ability to move the money tax free.

in the future you may have other direct real estate opportunities. Right now, money in hand helps a lot more than cashflow

[FIREshrink]

I'd sell to preserve the cap gain tax exclusion. You could, if you wanted to stay in real estate, then buy another property... but prices are pretty high right now in most markets, and you have that student loan debt so paying it off is probably better.

[SLC OB]

I agree with above, sell it. We have one that appreciated a lot but unfortunately, we have not lived there in last 5 years.... it is bringing in more $$ than yours but sure wish we had lived in it more recently, as I'd love to sell it now. Get out, pay off the loans and have a bit left over for your own home. Good luck and nice work.

[TXDoc21]

I’d say sell it. You did well in buying low and selling high. The $500 per month isn’t going to be worth the hassle for you.

Then I’d pay off the student loans. I know they are interest free right now, but that would be great to start attending life without student loans. Or you could hold the money until the interest rate climbs above 0%. Alternatively, you could invest it, but for peace of mind, I’d pay off the loans.

[Jaqen Haghar MD]

Bought at the low, sell high into a hot market. Focus your efforts on higher yield (>$500/month) activities. Congratulations. Move on one way or the other.

[White.Beard.Doc]

I am a physician real estate investor. However, in your shoes, I would sell now to take advantage of the tax benefits associated with the capital gains exclusion on a primary residence.

If you remain interested in owning investment real estate for tax diversification, there may be an opportunity with your ortho group once you become a partner. Do they own the building that houses the practice? Can you buy into that to take advantage of tax protected income and depreciation deductions? If that is not an option, you can certainly look at buying new real estate investment opportunities, but passing up the capital gains exclusion now would be a lost opportunity. At your soon to be income level, tax considerations are an important part of financial planning.

[ENT Doc]

I would personally get out of it. You are starting a new job and should be focused on that since it’s by far the greatest source of your income. The monthly cash flow you get from the rental is a rounding error on your A/R management. Plus your wife has her hands full.

As for the logistics, I’m not entirely sure how this would work given that this isn’t 100% owned by you. I’d defer to CPA or IRS experts here for that. But based on what you’ve said you should qualify for the 2/5 rule and be exempt from 500k in cap gains. However, you will owe money on the depreciation add back, which opens up a separate can of worms. There was a recent post by a CPA that covered this well. Basically your sale of a business property will end up on your 4797. The total gain will be broken up into two parts - depreciation allowable, and actual gains over your property’s basis. You won’t get taxed on the latter but your depreciation “gain” will flow to Schedule D and be treated in a special way (max 25% tax) based on the Schedule D tax worksheet. Any carry forward losses will also be realized and will flow to your schedule E and then your 1040. Lots of moving parts.

[robinhalldunn]

Dear WCI community,

I have a question that is a variation on the “pay down debt vs invest” theme you often get, but with a little real estate twist.

I’m a 36-year-old finishing my orthopedics sub-specialty fellowship. I have a wife who works for pay in addition to doing the heavy lifting in raising our two young kids (ages 3 and 5). I just accepted my first attending job with a for-profit multispecialty group in a moderate-to-high cost of living area. My wife and I will have a combined income of $600k when I start. We’ve done our best to live like residents throughout my training and we plan to going forward. We’ve maxed out Roth IRAs and 401ks and have contributed to 529s for our kids. We currently have about $200k in our retirement accounts and about $40k in our kids’ 529s. We also have about $50k in savings accounts that we’re hoping to use on a down-payment on a physician mortgage. I was lucky enough to get a partial scholarship for medical school, so I only have $140k in federal student loans (which are usually at 6.8% interest, but are now at 0% through Sept 2021 due to Covid-related federal relief).

My question is about a real estate investment that I made over a decade ago. Right after the 2008 crash, my best buddy from college and I purchased a small single-family residence with a mother-in-law apartment as an investment property. Over the years, each of us has used the place as a primary residence on and off, and most recently, my family and I lived in it throughout my 5-year residency before vacating one year ago. We originally purchased the house for just over $200k, and it is now valued around $550k. We still owe $140k on the mortgage, which is at 2.75%. So, by my calculations, my wife and I have just over $200k in equity in the property ([$550k - $140k]/2 = $205k). Currently, we rent out the house for roughly twice our monthly mortgage payment, which generates roughly $500 in income for my family each month.

My question is this: given that my family has lived in the house for 4 out of the last 5 years, we can claim it as our primary residence, and thus, any proceeds from sale of the property would not be subject to federal capital gains taxes. If that’s true, what is the most prudent use of the property at this point in my career: a) hold onto the property as an income property in order to get the tax benefits from depreciation and mortgage interest deductions (leaving open the possibility of doing a 1031 exchange down the road) or b) sell the property within the time window of the next 3 years during which my wife and I could use the capital gains tax-free proceeds from the sale to either pay off my student loans entirely or invest the money otherwise (in an investment that doesn’t tie me financially to my college buddy)?

Whew, thanks so much!