Hi again Sarah,
Larry offered some excellent advise in recommending that you sit down with your financial advisor. "Run the numbers" with a tax accountant or tax attorney knowledgeable in these matters. That is a first essential step.
However, and with all due respect to Larry, I think his experience of â€œ98%â€ of people gaining nothing is far from the reality in the Boston area. My experience with attorneys is also very different. I have not seen attorneys raking in excessive fees and complicating things for their clients. Apparently, things are much different in Durham than in Boston.
In fact, in every exchange I have been involved in or aware of, the facilitators were highly competent. Rather than complicating things, they clarified the process and demonstrated that, for an experienced, knowledgeable professional it is, in fact, quite straightforward. Furthermore, in the majority of cases, the facilitators charged no fees but rather received their paymentâ€”with agreement from the client, of courseâ€”by collecting interest on the funds which they held in escrow for six months or less.
It is obvious from your original question that you are aware of the $250,000 tax exclusion available ($500,000 if married filing jointly) and that it only applies to the 2/5 of your house which you maintained as your primary residence. If I understood you correctly, your question was "Can a 1031 tax exchange save me money on the 3/5 of property that was used for investment?" Also, "How complex is it?"
First of all, I do not agree that you are just â€œkicking your liability down the road and hoping that sometime in the future your liability will be less.â€ It is almost a certainty that upon retirement your income will be lower than it is currently and that your tax liability will be lower, possibly much lower.
But I think Larry misses the point in a more important way. 1031 exchanges are not just a method of saving taxes but a wealth-building vehicle. Instead of paying taxes on your proceeds you are reinvesting money which you would otherwise not have had at all! And you are putting that money into a more valuable investment and generating income from it!
And who says you have to sell and pay (reduced) taxes at a later time? If you wish to dispose of your investment property you could again exchange it for a different, more valuable one. Or you could hold it the rest of your life and bequeath it to an heir, never paying any tax at all! In that case, the property is no longer subject to capital gains tax but rather to estate tax which is greatly more favorable to your heirs.
So I would not be nearly so quick to tell you that there arenâ€™t â€œany real advantagesâ€ and to imply that you should just pay the 15% Federal long-term capital gains tax plus 5.3% to the Commonwealth. What is more, these amounts are current only to the end of this year. You may be aware that the 15% Federal rate is scheduled to increase to 20% beginning next January.
You may wish to explore the option of a tax-deferred exchange or you may not. You may decide never to sell your house! But my experience with Cambridge and Somerville clients doing tax-deferred exchanges is far different from what you may have concluded from some of the other responders. The key is to work with experienced and knowledgeable professionals who are dedicated to working in your best interest. There are many in our area. The process can be streamlined, safe and highly profitable. I have experienced it.
Regarding your comment about the condition of the house, that neednâ€™t necessarily be a concern either. As I mentioned previously, inventory has been particularly low for at least 18 months. You have certainly experienced this if you have been keeping an eye on the market for a multi-family home to purchase. Our market remains active with buyers of all types of property, buyers willing to pay well for good properties, properly marketed and presented.