Capital Gains Tax How To Avoid?
Ok...My ex-wife and I just sold our house last week...woo hoo...made a hell of a deal, she's been making payments for the last 5 years, and I walked away from the sale with $5600. I know not much for most of older investors but hey I did nothing but find the seller and put maybe $2000 in for a down payment, that's more than 50% return.
Now here's my dilema, because I haven't lived in the house for the last 5 years I subject to Capital Gains tax right?
Now am under the impression that if you reinvest the money in real estate within 6 months it won't be subject to Capital Gains Tax. First is this correct? Second, can I use the money as earnest money/down payment on a new home that I want to build but won't be complete for 7-8 months and still avoid capital gains? Or does the property have to be in my name within 6 months?
Scott <IMG SRC="images/forum/smilies/icon_eek.gif">
[ Edited by illusvfyre on Date 11/18/2003 ][ Edited by illusvfyre on Date 11/18/2003 ]
It's been awhile since I had to be aware of how this and it probably has changed somewhat.
The rule was that the house had to be YOUR primary residence for 2 of the past 5 years. Then you had 2 years to buy your new home with the money.
Since you don't qualify here it looks like you're stuck with capital gains. Once it's in your pocket IT'S TAXED.
I have never heard of a deferment you referred to.
Sorry
Jim
Do you know about a 1031 exchange?
Scott,
If your ex was granted use of the property under a divorce or separation agreement, then you may still be treated as using the property as a principal residence during your ex's use. Hence, no taxable capital gain here.
On the other hand, if your ex received title to the property in your divorce decree, then this transfer of property in your divorce settlement is treated as a tax-free gift. This also transfers all of the tax liability on the sale of the property to your ex, though she may have no capital gains taxes if she otherwise qualifies for the capital gains exclusion. If your ex gave you any money from the proceeds of the sale, I would treat it as a tax free gift -- no need to report it as income on your tax return.
Now that you know that you won't have any income tax liability on the $5600 you received, the rest of your questions are just academic. But, let's address your six month re-investment question.
You are probably thinking about a tax-deferred exchange. A tax deferred exchange allows you to exchange investment property for other investment property without creating a taxable event. A deferred exchange allows you to sell your investment property and use the proceeds to purchase a replacement property without recognizing any capital gains on the "sale" of the relinquished property. There are specific rules governing the exchange and failure to comply with any of the rules will disqualify the exchange entirely. The entire exchange must be completed within 6 months, and you can never take possession of any of the proceeds of the sale of the relinquished property.
In your case, the property in question was not investment property and you took possession of some of the proceeds from the sale. Your eligibility to participate in a tax-deferred exchange fails on two counts. If you want to read the tax code on this, look up Section 1031.
But, as I said earlier, this is just academic because (in my opinion) you don't have a taxable capital gain in the first place.
Please consult a licensed tax professional in your area for specific details. [ Edited by DaveT on Date 11/18/2003 ]
I totally agree with DaveT. Great post! Consider it for an article!
OK, Thanks Dave. Just one thing, she wasn't granted anything in the divorce, because we were all ready divorced at the time. The thought of remarriage was on our minds when we bought the house. Though that never happened. My name has been on the the mortgage and title/deed since then never quit claimed. We both went to closing and we received seperate checks. Does this still qualify under your first scenario?
Thanks for the help,
Scott
Unfortunatly I belive you will have to either roll this investment though a 1031 or just pay the capital gains tax. Since the profit is so low, I might consider just paying the tax.
What do you think Dave?
I would definatly recommend to go talk to an accountant.
If you have already take possition of the funds I don't believe you are able to do a 1031. You have to have someone hold the funds. (like escrow) This is what we had to do. We went the day after closing to try a 1031 and we weren't eligible.
Best to you,
Sire [ Edited by sire on Date 11/18/2003 ]
Just goes to show you that the advice you receive is only as good as the information you give your advisor.
With this new information, it now appears that your participation is that of investor. Your share of the profit carries a maximum capital gains tax rate of 15% if you are in the 25% tax bracket or higher, but the capital gains tax rate is only 5% if your marginal tax bracket is 15% or lower.
If you consider your initial basis as the $2000 down (because you made no other contributions to the property), then your profit is only $3600 ($5600 - 2000). In the worst case, your tax liability will only be $540. You will spend much more than that trying to shelter it from taxes -- even though a 1031 exchange is no longer available to you. After you pay the federal income taxes, you will have $5060 to pay your state income taxes then play with whatever is left over.