DEAR BOB: What would be the process to trade two homes for one? The two homes are valued at $1.5 million total. The home for sale is valued at $1.2 million. The seller will trade. What is the first step to take? –Phyllis S.
DEAR PHYLLIS: If I understand your question correctly, you want to trade two rental houses worth a total of $1.5 million for one rental house worth $1.2 million. That would be a partially taxable trade down because the two rental houses are worth $300,000 more than the one rental house being acquired.
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This could get a bit complicated because there is the 25 percent depreciation recapture tax to consider in such a down trade.
If the owner of the $1.2 million rental house is willing to take your two rental houses and pay you the $300,000 cash difference, that would be the easiest way to go.
However, if he is not willing to pay you $300,000 cash, you should then consider selling the two rental houses in a Starker delayed tax-deferred exchange using Internal Revenue Code 1031(a)(3).
That means you sell your two rental houses for cash, have the sales proceeds held by a qualified third-party intermediary accommodator beyond your constructive receipt, and then within 45 days after the first sale closes designate the property to be acquired. You then have up to 180 days to complete the acquisition.
After the purchase is completed, then you will receive the $300,000 cash “boot,” which is taxable to you. For details, please consult a tax adviser experienced with IRC 1031 tax-deferred exchanges.
IS RENTAL CAPITAL GAIN TAX 15 PERCENT OR 40 PERCENT?
DEAR BOB: I have owned a rental property for a year. If I sell it in the next few months, what is the capital gains tax I will pay? I read an answer you gave someone that the government wants a 25 percent tax back on the depreciation. Does that mean the government gets a total tax of 40 percent? –Steve B.
DEAR STEVE: No. If you owned your rental property at least 365 days, you qualify for the federal long-term capital gain tax rate, which is a maximum of 15 percent.
However, a portion of your capital gain that is due to the depreciation you have deducted will be “recaptured” (that means taxed) at the special federal depreciation recapture tax rate of 25 percent (instead of 15 percent tax on the balance of your capital gain).
In addition, don’t forget the state tax, unless the property is located in one of the lucky states without income tax. For full details, please consult your tax adviser.
DOES STEPPED-UP BASIS APPLY TO LIVING-TRUST ASSETS?
DEAR BOB: I understand the rule for stepped-up basis to market value on the date of death for inherited property. Does that same rule apply to my house that is held in my living trust? –Andrew G.
DEAR ANDREW: Yes. Holding title to your house and other major assets in your revocable living trust does not deprive your heirs of the benefits of stepped-up basis on inherited property. They will thank you for leaving your assets to them via your living trust, thereby avoiding probate court costs and delays.
But they will still get the same stepped-up basis to market value on the date of your death as if your property went through probate. More details are in my special report, “24 Key Questions Answered: Living Trust Secrets Reveal How to Avoid Probate Costs and Delays,” available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com. Questions for this column are welcome at either address.
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