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Save Taxes on the Sale of Real Estate

Esther A. Streete


Please be advised that in order to ensure our firm is in compliance with the new rules and standards as provided in Circular 230 by the Internal Revenue Service, we are informing you that any tax advice contained in this communication is not intended or written to be used for the purpose of avoiding penalties that may be imposed on the taxpayer.

The Internal Revenue Service recently issued guidance on how a taxpayer can save taxes on the sale of a personal residence, which was converted to rental property.

Prior to the issuance of this new guidance, a taxpayer that converted a personal residence to rental property or vice versa, had to choose between excluding gain on the sale of a personal residence or the deferral of gain in a like-kind exchange. With the issuance of Revenue Procedure 2005-14, taxpayers who meet the requirements for gain exclusion under IRC § 121 and gain deferral under IRC § 1031 do not have to choose and can reap the tax benefits of both Code sections.

In order to take advantage of both Code sections, the property must meet certain qualifications. IRC § 121 permits a taxpayer to exclude up to $250,000 ($500,000 if married filing joint) of gain on the sale of a principal residence as long as the taxpayer owned and used the property for at least 2 of the last 5 years as a principal residence. Secondly, IRC § 1031 provides for the deferral of realized gain when property held for productive use in a trade or business or for investment is exchanged for like-kind property to be held for productive use in a trade or business or for investment. To the extent that the taxpayer also receives cash or other non like-kind property, known as "boot", gain must be recognized. Assuming the taxpayer meets both requirements, IRC § 121 must be applied before IRC § 1031.

Gain on the sale of real estate can be quite significant, especially in our current real estate market, and the resulting taxes on that recognized gain can also be substantial. Tax advice should be sought to ensure that the requirement for these tax savings provisions are met and to receive guidance on how to save taxes on the sale of real estate. If you have any questions or would like to discuss how this new guidance might apply to your specific situation, feel free to contact Esther Streete at 301-441-2420.