Combining principal residence and vacation home

Dear Mr. Hickox:  I have a primary residence and a beach house and I want to  sell both of them and build a new primary residence.  I want to apply the  money from my other two houses to my new primary residence.  How am I  affected by Capital Gains?

 

Dear N: Under IRC section 121 the first $250K ($500K if married) of GAIN upon sale of principal residence is tax exempt, as long as you have owned and lived in the residence for 2 of the last 5 years.  Any gain over that amount is taxed as long term capital gains.  With regard to your beach house, any gain on that transaction will be taxed at long term capital gains rate, unless you have held that property "primarily" for investment purposes.  If you have held it primarily for investment purposes then it could be eligible for tax deferral under IRC section 1031.  The problem then is your goal to use all proceeds to build a new principal residence.  Unless part of the new principal residence has an exclusive business use then 1031 exchanging into the principal residence will not qualify for 1031 replacement property.  In short, the gain from the sale of the beach house will, in all likelihood, be subject to long term capital gains tax.  Finally, you will also be subject to state income tax for the state in which the property is located and/or the state in which you reside.  Let me know if you need more. 

Dear Mr. Hickox Could "exclusive business use", in my new principle residence be considered an office that will be used for conducting business affairs such as farm maintenance?  Also, could I use the profits from my beach sale to buy some land, not including the land that the new house is on?  And one other question, how do I determine the actual amount that I have tied up in the house versus the new sale amount to get the taxable portion?

 One final question can I refinance the house, take the money out, then sale it and only pay the difference in taxes?

 Thanks for your help!

Dear N: Yes a home office qualifies as investment property.  You could trade the beach house for the home office. BUT, in order to defer ALL taxes you must trade equal or up in value.  In your case you might achieve some benefit from the 1031x with some taxes to pay as well. Yes you could buy some vacant land which you hold for investment, even the adjoining lot with the 1031 proceeds from the beach house.  Therefore the 1031 might be sell beach house and buy adjoining vacant land.  Finally, the size of the mortgage and the tax liability are UNRELATED.  Increasing the size of the mortgage will not change the tax liability, nice try.   Sincerely,

Steve Hickox
Attorney / President

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