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I bought the property in 1979 for $40K. It was zoned R4 and was a duplex. Several years later, the city camein and did a blanket rezoning of the entire street to C-2. I shared the house/owner-occupied rental property; I lived there until 2002. It has been leased to the same tenants for 6 yrs. They want to buy it, but I don't really want to sell it. I live in California and the property is in Kentucky, so it would be a real hassle to re-lease it.

The property is now worth around $400K. I have made BIG improvements over the years, and have taken them off my taxes each year. The building has been depreciated out. I owe $185K on it.

What are the best options for me in order to not have to pay exorbitant capital gains taxes? This is my only asset. I am a retired teacher and get my monthly retirement of $2700. I have very little savings and this building has been a real godsend financially.

Would carrying "paper" on it defer the capital gains on that part of the profit? I know about the 1031 trade, but I don't understand how the equity thing works. Say I trade for a $400K income property. My monthly payments now are approx $1700 PITI. Would that change? If they did a lease/purchase option, how does that work? Of say $3000/mo rent, what is the "going %" or fair % of that rent that would go toward the purchase price? What is a good amount of time for the lease/option?

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    There are enough issues and incompletely specified facts here that any attempt at an answer is likely to be off-target. I would recommend a consultation with someone closer at hand instead of relying on an answer from an Internet forum.
    – Dilip Sarwate
    Sep 8, 2013 at 15:53

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"and have taken them off my taxes each year" - true improvements, and not just maintenance/repairs are not 'taken' but depreciated over their life.

Property (i.e. land) is not depreciated, but you bought so cheap, you may have only a $5K basis. So today, you sell for $400K, and net $375K after realtor fee. Less $185K mortgage, leaving $190K cash. Nearly the whole $400K is a gain, which I believe (meaning not 100% sure) is subject to 15% cap gain rate or about $60K tax. You'll net $130K or so. If you are getting $3000/mo income, some of which goes to principal in that mortgage payment, even the $1300/mo left is a great return on your equity.

A 1031 exchange is the only way I know to avoid the tax issue. It looks to me like you should find a local realtor and stay renting this out. Just my observation from the details you provided.

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You should get a proper tax consultation with a EA/CPA licensed in California (and KY would be good, however its probably rare to have a CPA to be licensed both in CA and KY). This is not trivial at all.

1031 exchange is one way to sell the property to avoid taxes, but you will have to pay some taxes on the amounts used to pay off the debt (this is "boot received", and is taxable).

Another thing to remember is the depreciation recapture. Although not much in your case (up to 40K), it is still something to keep in mind - taxed higher than the regular capital gains.

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  • +1 - you caught a few things I missed. Never heard of 'boot' and ignored the dividend recapture as that's a small part of the issue, but can't be ignored.
    – JTP - Apologise to Monica ♦
    Sep 8, 2013 at 22:11

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