I'm planning on selling an investment property (a condo in WA state). I've owned this property since 2004. I lived in it as my primary residence from 2004 to October of 2007.

I'm planning on taking the profit from this sale and investing it into another investment property that I own.

I'm planning on refinancing the mortgage on this other investment property because with the profit from the sale, I think I can get get better terms (by getting rid of PMI and the fact that it will be a conventional loan (i.e. the loan will be for less than 80% of the appraised value)).

Is there something else I need to be thinking about here? I'm assuming that I will not have to pay capital gains tax on the profit from the sale because I'm putting it into another investment property. Is this correct?

EDIT: I do not qualify for the primary residence exclusion. I listed my move-out date as 2010, but it was really 2007.

Thanks for your help, all. I asked a follow up here

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    Good question. FYI, it is advisable to wait a couple of days to see if you can get some more responses before accepting. @littleadv is correct and there isn't anything wrong with the answer ( and so you should also vote it up too ) but giving others a chance to post an answer might get you some extra good info. We are eager to hear the next questions that arise from your sale. Congrats. – MrChrister Jun 10 '13 at 18:03
  • @MrChrister, makes sense. I'm still figuring out SE etiquette :) – three-cups Jun 10 '13 at 18:07
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    Stick around, we are pathologically compelled to be helpful. – MrChrister Jun 10 '13 at 18:14

Is there something else I need to be thinking about here? I'm assuming that I will not have to pay capital gains tax on the profit from the sale because I'm putting it into another investment property. Is this correct?

No. You're talking about 1031 exchange. It would be correct if you would be buying a new, similar, investment property (you'd be deferring the tax, not "not paying" it). But in this case that is not what you're doing. You'll have to pay the capital gains tax on the profit. For the 1031 exchange the new property has to be acquired with relation to the disposition of the old property, and within the certain period of time (180 days, if I remember correctly).

Had it been your primary residence for more than 2 years in the last 5, you might have been able to use the primary residence exclusion, in which case you would not be paying tax on the excluded gains (which is way better than deferring...). Since you updated the question saying you moved out in 2007, its not relevant for you anymore.

Adding to @mhoran_psprep's point: since it has been a rental for the last several years, you will also have a "depreciation recapture" - a situation where the IRS will tax a deduction you made (or could have made) for depreciation of your property. Since you can not depreciate your primary residence - the recapture cannot be excluded as part of the primary residence exclusion, so on this part you will have to pay taxes. Note that this is not capital gain, and the recapture rates are different (25% if I remember correctly).

You should discuss it with your tax adviser - a EA or a CPA licensed in your state.

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    Wow, good thing I asked! Thanks for the advice. I'll contact my CPA today. – three-cups Jun 10 '13 at 17:51
  • Thanks, but I actually listed my move-out date incorrectly. It is 2007, not 2010. So I do not qualify for the PRE. – three-cups Jun 10 '13 at 20:19
  • Updated my answer for you, to also include other points raised by others – littleadv Jun 10 '13 at 20:22
  • Would a 1031 exchange work if I purchased a primary residence with the proceeds of the sale? Or is an investment property to a primary residence not a like for like? – three-cups Jun 10 '13 at 23:39
  • @three-cups I'd suggest you ask your CPA this question, but IMHO its not like for like (one is rental the other is not). – littleadv Jun 11 '13 at 0:20

When determining your capital gains you also might have to recapture the amount of depreciation that you have/should have claimed during the last 2+ years you held the property as an investment.

If you are going to treat it as the sale of principal residence, make sure you act soon. To claim 2 out of 5 years that means that the investment period has to be 3 years or less. Sometime in the next few months that window will close.

  • +1 and worth noting that the depreciation recapture cannot be excluded, so at least some tax will be paid. – littleadv Jun 10 '13 at 19:43

Remember that the IRS have very specific rules and timetables on how to defer capital gains on like-kind exchanges; also known as a 1031 exchange. Something your CPA or tax attorney will discuss with you.

  • Welcome Henry. Would you mind elaborating a bit more on the 1031 exchanges? You can use the question as a basis for an example. When would the 1031 apply and when wouldn't it apply? Of course professional advice is always recommended, a robust summary would make for a good answer. – MrChrister Jun 10 '13 at 19:51
  • 1031 is not applicable in this scenario though – littleadv Jun 10 '13 at 19:57

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