Reinvesting tax break
July 25, 2014 8:57 AM Subscribe
My father owns several acres of land that was given to him by his father when he was 16 or so. He is finally trying to sell it. He is under the impression that after the age of 55 (he is in his 60's and retired), you are entitled a one time tax free reinvestment. Is this true?
He plans to take the money from the sale of the land and immediately buy a second home closer to us, then get their current home ready to sell. Is this a real thing or something he just heard a snippet of and is incorrect in his understanding? He will of course consult a professional when the time comes, but I would like to get a better understanding myself.
He and my mom have been planning to move to our town once she retires and is pinning all their future plans on this tax break. I don't want them to be disappointed if this isn't really a thing. They have some developers interested in the property already, so it may only be a matter of months.
Again, he will consult a professional, but until then what say the hive?
He plans to take the money from the sale of the land and immediately buy a second home closer to us, then get their current home ready to sell. Is this a real thing or something he just heard a snippet of and is incorrect in his understanding? He will of course consult a professional when the time comes, but I would like to get a better understanding myself.
He and my mom have been planning to move to our town once she retires and is pinning all their future plans on this tax break. I don't want them to be disappointed if this isn't really a thing. They have some developers interested in the property already, so it may only be a matter of months.
Again, he will consult a professional, but until then what say the hive?
I understand that it used to be the case that you could avoid capital gains if you bought another house with the proceeds within some time span. That has changed, however and now, there is no capital gains tax on the sale of your primary residence. (under some dollar amount, like 500k for a married couple).
That however, may not apply to land that is not a homestead. You'd really need to talk to a tax professional in your area. Even to whatever extent federal taxes may or may not apply, state and local taxes will also vary.
posted by Pogo_Fuzzybutt at 9:13 AM on July 25, 2014 [1 favorite]
That however, may not apply to land that is not a homestead. You'd really need to talk to a tax professional in your area. Even to whatever extent federal taxes may or may not apply, state and local taxes will also vary.
posted by Pogo_Fuzzybutt at 9:13 AM on July 25, 2014 [1 favorite]
Are you in Canada by any chance? There is a lifetime capital gains exemption for the sale of farmland (and some other things, like small businesses). There are rules about it, I don't know if your father's land applies since it will be sold for development.
posted by quaking fajita at 9:21 AM on July 25, 2014
posted by quaking fajita at 9:21 AM on July 25, 2014
Your Dad would be well served by having a conversation with a tax accountant or a real estate attorney (or both!)
Guessing, half-remembering, etc...just BAD. Call a pro and get counseled. Seriously, it's worth the $300 or so bucks he'll spend.
posted by Ruthless Bunny at 9:26 AM on July 25, 2014 [1 favorite]
Guessing, half-remembering, etc...just BAD. Call a pro and get counseled. Seriously, it's worth the $300 or so bucks he'll spend.
posted by Ruthless Bunny at 9:26 AM on July 25, 2014 [1 favorite]
Best answer: In the United States, before 1997, there were special rules about capital gains on home sales that applied to people aged 55 and older. (I believe he's even confused about that, because I think that the reinvestment rule applied to people younger than 55, and that for the older people there was an exemption even if you didn't reinvest, but I can't quickly find the old rules and it doesn't matter now.)
Now there is, regardless of age, an exemption of $250,000 (for singles) and $500,000 (for couples) on profits from the sale of a primary residence. Generally, "You are eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale." See http://www.irs.gov/taxtopics/tc701.html for details.
However, it sounds like his actual home is separate from the land you're talking about.
Hermes32 mentions like-kind exchanges, which is a way of deferring taxes. Basically, you sell investment 1, buy investment 2, and so don't owe taxes on the gains on investment 1 until you sell investment 2. However, according to the IRS, "Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment." So it appears that they cannot simply sell the land and buy a house to live in without paying taxes on the gains they realized on the land. The IRS says that "Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land." So perhaps they could do something like buy a house and rent it out mostly and live in it some of the time, but that's what the tax advisors get paid the big bucks to figure out.
Another complicating factor will be determining the basis of the land - that is, how much was it worth 50 years ago when he received it. The higher the original value, the lower the profits and the lower the taxes.
Finally, he's unlikely to face a capital gains rate of more than 20%, so if, for example, the land was basically worthless and is now worth $100,000, he's still taking home at least $80,000.
Again, not a substitute for real advice, but hope this is helpful background.
posted by Mr.Know-it-some at 9:27 AM on July 25, 2014 [2 favorites]
Now there is, regardless of age, an exemption of $250,000 (for singles) and $500,000 (for couples) on profits from the sale of a primary residence. Generally, "You are eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale." See http://www.irs.gov/taxtopics/tc701.html for details.
However, it sounds like his actual home is separate from the land you're talking about.
Hermes32 mentions like-kind exchanges, which is a way of deferring taxes. Basically, you sell investment 1, buy investment 2, and so don't owe taxes on the gains on investment 1 until you sell investment 2. However, according to the IRS, "Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment." So it appears that they cannot simply sell the land and buy a house to live in without paying taxes on the gains they realized on the land. The IRS says that "Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land." So perhaps they could do something like buy a house and rent it out mostly and live in it some of the time, but that's what the tax advisors get paid the big bucks to figure out.
Another complicating factor will be determining the basis of the land - that is, how much was it worth 50 years ago when he received it. The higher the original value, the lower the profits and the lower the taxes.
Finally, he's unlikely to face a capital gains rate of more than 20%, so if, for example, the land was basically worthless and is now worth $100,000, he's still taking home at least $80,000.
Again, not a substitute for real advice, but hope this is helpful background.
posted by Mr.Know-it-some at 9:27 AM on July 25, 2014 [2 favorites]
Response by poster: We are in the US. He will consult someone for sure, but I think he was waiting till things got closer. I will push them to speak to someone asap rather than 'at some point'.
This is exactly why I knew I could get more details from the hive! My dad has a heart of gold but tends to be like a dog with a bone once he gets an idea in his head, regardless of how much real info he has.
posted by MayNicholas at 9:36 AM on July 25, 2014
This is exactly why I knew I could get more details from the hive! My dad has a heart of gold but tends to be like a dog with a bone once he gets an idea in his head, regardless of how much real info he has.
posted by MayNicholas at 9:36 AM on July 25, 2014
Best answer: The comments above, especially Mr.Know-it-some have it right. IAL and this is in my area of practice.
Just a quick summary:
Basis: The land was a gift at age 16 so his basis (what he is considered to have 'paid for it') is the basis that his FATHER held in it. So question 1 is - what did father (your grandfather) pay for it.
Capital gains: Since it is not his home it is considered a long term capital investment. This is true without regard to whether he ever derived income from renting it, etc. Even a bare patch of ground on these facts is a "long term capital asset." So, when he sells it he will owe long term capital gains taxes on the sale price minus his basis. Mr.know-it-some's hypothetical is right as to what portion of sale price is gain.
He cannot sell it and "reinvest" all the money into a residence. He must pay tax on sale.
A "like-kind" exchange. Also called a 1031 exchange is a way to DEFER but not avoid taxes.
Basically he sells what he has and buys a replacement investment property with the money. The rules are complex and I'm being WAY too simplified here. But if done correctly his "basis" in the newly acquired investment property is the same as his basis in the original property (grandpa's purchase price) but no tax is owing at this transaction. Should he ever sell the replacement property long term capital gains taxes are owing then.
The 1031 exchange method is often referred to as "roller coaster" investing. Because once you get on its very hard to get off.
BUT, if he could roll the value into a property (apartment building, the like) that provided income to him during his life he could pass it to heirs / devisees in an appropriate estate plan and potentially avoid the capital gains taxes all together. If that option is interesting to him he needs to consult competent estate planning counsel in his jurisdiction. I'd recommend one who is a member of ACTEC - The American College of Trust and Estate Counsel.
Hope that helps.
posted by BrooksCooper at 4:10 PM on July 25, 2014 [1 favorite]
Just a quick summary:
Basis: The land was a gift at age 16 so his basis (what he is considered to have 'paid for it') is the basis that his FATHER held in it. So question 1 is - what did father (your grandfather) pay for it.
Capital gains: Since it is not his home it is considered a long term capital investment. This is true without regard to whether he ever derived income from renting it, etc. Even a bare patch of ground on these facts is a "long term capital asset." So, when he sells it he will owe long term capital gains taxes on the sale price minus his basis. Mr.know-it-some's hypothetical is right as to what portion of sale price is gain.
He cannot sell it and "reinvest" all the money into a residence. He must pay tax on sale.
A "like-kind" exchange. Also called a 1031 exchange is a way to DEFER but not avoid taxes.
Basically he sells what he has and buys a replacement investment property with the money. The rules are complex and I'm being WAY too simplified here. But if done correctly his "basis" in the newly acquired investment property is the same as his basis in the original property (grandpa's purchase price) but no tax is owing at this transaction. Should he ever sell the replacement property long term capital gains taxes are owing then.
The 1031 exchange method is often referred to as "roller coaster" investing. Because once you get on its very hard to get off.
BUT, if he could roll the value into a property (apartment building, the like) that provided income to him during his life he could pass it to heirs / devisees in an appropriate estate plan and potentially avoid the capital gains taxes all together. If that option is interesting to him he needs to consult competent estate planning counsel in his jurisdiction. I'd recommend one who is a member of ACTEC - The American College of Trust and Estate Counsel.
Hope that helps.
posted by BrooksCooper at 4:10 PM on July 25, 2014 [1 favorite]
Response by poster: Thank you for more great advice!
His father (my grandfather) got the land from his father. His father may have gotten it from his father and so on. Our family were some of the original founders of that town (not folk lore) and had tons of land at some point, all that is left is this wooded lot. Super fascinating to me, but not relevant at all.
posted by MayNicholas at 4:29 PM on July 25, 2014
His father (my grandfather) got the land from his father. His father may have gotten it from his father and so on. Our family were some of the original founders of that town (not folk lore) and had tons of land at some point, all that is left is this wooded lot. Super fascinating to me, but not relevant at all.
posted by MayNicholas at 4:29 PM on July 25, 2014
Response by poster: I sent him the link to the irs site on like kind exchanges and my dad just responded with "Thats the Principle idea but I don't think thats the one ..its a one time deal over 55 of age"
Is there something I am missing? I want to stress to him, if his facts are incorrect, that he needs to talk to someone asap.
posted by MayNicholas at 5:23 PM on July 25, 2014
Is there something I am missing? I want to stress to him, if his facts are incorrect, that he needs to talk to someone asap.
posted by MayNicholas at 5:23 PM on July 25, 2014
Best answer: As I mentioned, he is thinking (incorrectly) about the pre1997 law. This article might help him, as it specifically discusses what the law was before 1997:
"Some sellers are surprised by this break, especially if they've been in their homes for a while. That's because before May 7, 1997, the only way you could avoid paying taxes on your home-sale profit was to use the money to buy another, more-expensive house within two years. Sellers age 55 or older had one other option. They could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. And in all instances, there was tax paperwork (Form 2119) to fill out to show that you followed the rules.
But when the Taxpayer Relief Act of 1997 became law, the home-sale tax burden eased for millions of residential taxpayers. The rollover or once-in-a-lifetime options were replaced with the current per-sale exclusion amounts."
That is, the tax preference for primary residence is actually more generous than before, but it's still only applicable to primary residences (as it was before), and the once-in-a-lifetime part no longer applies to anything.
Maybe once he sees that the once-in-a-lifetime provision was repealed he'll believe that he needs to learn more.
posted by Mr.Know-it-some at 7:08 PM on July 25, 2014 [2 favorites]
"Some sellers are surprised by this break, especially if they've been in their homes for a while. That's because before May 7, 1997, the only way you could avoid paying taxes on your home-sale profit was to use the money to buy another, more-expensive house within two years. Sellers age 55 or older had one other option. They could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. And in all instances, there was tax paperwork (Form 2119) to fill out to show that you followed the rules.
But when the Taxpayer Relief Act of 1997 became law, the home-sale tax burden eased for millions of residential taxpayers. The rollover or once-in-a-lifetime options were replaced with the current per-sale exclusion amounts."
That is, the tax preference for primary residence is actually more generous than before, but it's still only applicable to primary residences (as it was before), and the once-in-a-lifetime part no longer applies to anything.
Maybe once he sees that the once-in-a-lifetime provision was repealed he'll believe that he needs to learn more.
posted by Mr.Know-it-some at 7:08 PM on July 25, 2014 [2 favorites]
He's half-remembering the tax laws pre-1997, as Mr. Know-it-some describes. My parents were maddening on the subject themselves. "Oh! If you sell your house for a profit, you have to roll it into the next purchase OR ELSE YOU'LL BE TAXED!"
My Dad is the same way. In 1964 he and my mother bought a house through the GI bill for $9,000 in Stockton. He's STILL convinced that deals like that are available if only you'd look hard enough, and be willing to paint. I'm serious.
The law he's referencing was for primary residences only. Not investment property.
Good luck, my Dad will pretend to agree when I show him evidence, and then pretend the conversation never happened.
posted by Ruthless Bunny at 5:47 AM on July 26, 2014
My Dad is the same way. In 1964 he and my mother bought a house through the GI bill for $9,000 in Stockton. He's STILL convinced that deals like that are available if only you'd look hard enough, and be willing to paint. I'm serious.
The law he's referencing was for primary residences only. Not investment property.
Good luck, my Dad will pretend to agree when I show him evidence, and then pretend the conversation never happened.
posted by Ruthless Bunny at 5:47 AM on July 26, 2014
The above are correct. What he thinks he can do could never be done. There was a similar "loop hole" as it were in pre-1997 law that we all now get on sale of residences, regardless of age.
There is no possible way for him to turn this property into cash without a huge fraction of the value (possibly more than 50%) going to taxes. If he won't believe this, get him to a lawyer and let them try to explain. If he won't believe - stand back and watch the train wreck happen.
Sorry.
posted by BrooksCooper at 4:38 PM on August 12, 2014
There is no possible way for him to turn this property into cash without a huge fraction of the value (possibly more than 50%) going to taxes. If he won't believe this, get him to a lawyer and let them try to explain. If he won't believe - stand back and watch the train wreck happen.
Sorry.
posted by BrooksCooper at 4:38 PM on August 12, 2014
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Best to consult a tax professional and a real estate professional.
posted by tckma at 9:00 AM on July 25, 2014