As a real estate investor, it’s wise to understand all of the tax codes that allow you to minimize your tax liability. You can contact our team at Diversified Investment Strategies anytime to discuss what options are available to you, in order to minimize the amount of taxes you must pay on a property when you go to sell. We can help you choose the best options for your unique situation.
If you are familiar with 1031 Exchanges and 121 Exclusions, we are here today to discuss how you might use both to your advantage. 1031 exchanges deal with properties that are used for investment use only, and 121 exclusions are used for privately owned residences, so you might think that the two are exclusive of each other. However, there are a few situations where you could implement both when you go to sell.
With a 121 exclusion, you’re eligible to use if you have owned and used a property as your main home for a period of at least two years out of the five years prior to its date of sale. Therefore, if you own a residence and live in it, but then turn it into investment property, you may incorporate the 121 exclusion and 1031 exchange when you go to sell, as long as you meet all the requirements for both.
For example, a family lived in a home as their primary residence for 15 years, then moved out and began renting the property in 2017. They rented the property for two consecutive years, which qualifies the property as an investment property for a 1031 exchange.
When they sell, the family can first use a 121 exclusion to exempt them from some or all of the gain on the sale. The amount gained cannot exceed $250,000 for a single filer, or $500,000 for a married filer. Therefore, if the gain is above this amount and taxes still need to be paid on the remaining gain, this family could then use a 1031 exchange on the remainder of the net proceeds.
Of course, in order to do this, the family would have to meet all of the requirements of a 1031 exchange as well. They would need to buy a like-kind replacement property in the necessary timeline, which is equal or of greater value than the equity of the relinquished property.
Another circumstance in which an investor could benefit from combining a 121 exclusion and a 1031 exchange is if they own and rent within the same property, such as a duplex or apartment building. If they live in the property, but also rent part of the property out as an investment, this investor may be able to combine the two if all requirements and timelines are met.
As always, contact our team at DIS with any questions you may have! We are here to help!