1031 exchange and principal residence

Dear 1031x: We bought a house for 485,000 and have refinanced the house for  both landscape upgrades and also to eliminate some debt.  We now owe  $700,000.  The market value of the home is 1,200,000. Would the husband  and wife $500,000 tax exclusion be based on the 500,000 purchase price or  the 700,000 balance that is now owed on the house?

Dear J:  Your gain will be calculated by subtracting your tax basis from your sales price (minus costs of selling).  In your case your basis is probably close to your purchase price (unless you made capital improvements to the property which would increase your tax basis)  The size of the mortgage bears no relationship to your gain.  Therefore, simplistically your gain will be the difference between $485K and $1.2M. After you add capital improvements and subtract costs of selling, then apply the $500K exemption (IRC section 121)  you will probably still have a small tax liability.  Not a bad place to be. 

Steve Hickox
Attorney / President

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