Can apartments be traded tax-free for a rental house?

DEAR BOB: My wife and I own a four-unit rental apartmentbuilding that we want to trade for a rental house where we would ultimatelylike to live. Would such a trade qualify as tax-deferred? If the answer is”yes,” will Uncle Sam recapture and tax the depreciation we havededucted on the rental apartments? –Corrie A.

DEAR CORRIE: As long as you trade equal or up in both priceand equity, your proposed exchange of the apartment building for a rental housecan qualify as a tax-deferred exchange using Internal Revenue Code 1031.However, the acquired rental house should be rented to tenants at least six to12 months to show rental intent at the time of the exchange.

Purchase Bob Bruss reports online.

If you plan to do a Starker delayed tax-deferred IRC1031(a)(3) exchange, please be aware you have only 45 days after the sale ofthe apartment building to designate the replacement rental house and up to 180days to complete the acquisition.

Because this is a tax-deferred exchange, your depreciationdeductions will not be “recaptured” (which means taxed) at the timeof the trade. If you eventually sell the rental house, at that time thedepreciation will be recaptured and taxed at the special 25 percent federal taxrate.

If you own the rental house “forever” until youdie, Uncle Sam will be so overcome with grief at your passing he will forgiveany capital gain or recapture tax that would be due if you sold that propertyduring your lifetimes.

One last important comment: If your plan is to eventuallysell the rental house, after moving in and converting it to your principalresidence, to qualify for the Internal Revenue Code 121 tax exemption up to$500,000 for a married couple filing jointly (up to $250,000 for a singleowner), you must 1) occupy the principal residence at least 24 of the 60 monthsbefore its sale, and 2) own the house acquired in a tax-deferred exchange forat least five years.

This five-year ownership tax law change was effective Oct.22, 2004, but only for homes acquired in tax-deferred exchanges. For fulldetails, please consult your tax adviser.


DEAR BOB: We are buying our first home and finding it quitean adventure. In my work, I negotiate contracts with lots of wonderful as wellas sleazy businesspeople. But that is nothing like some of the extremelyunpleasant home sellers we have encountered in the last few months. However, wefinally found a home we want to buy. The purchase offer was accepted. Ourbuyer’s agent strongly encouraged us to sign the arbitration clause in theprinted sales contract. But we decided not to sign. Did we do the right orwrong thing? –Daryl R.

DEAR DARYL: Yes, you did the right thing. Congratulationsfor not signing that arbitration clause in your home purchase contract.

If you had signed it, in the event of a future dispute withthe home seller, perhaps over undisclosed house defects, you would have givenup your right to a jury trial, court rules of evidence and discovery, and theright to appeal. You would be at the mercy of an arbitrator.

The moment of buying a home is stressful enough. Why give upyour future legal rights at the same time? If a dispute arises in the futurewith the home seller, at that time after discussing the matter with yourattorney, you and the other party can decide if arbitration is appropriate.


DEAR BOB: What is your opinion of the new so-called”option mortgages?” If I understand them correctly, we can refinanceour home with an option mortgage and then decide each month if we want to paythe full 30-year amortized mortgage payment, interest only, or a partiallyamortized payment. Do you recommend these mortgages? –Cynthia F.

DEAR CYNTHIA: The answer depends on how long you expect tostay in your home. If the answer is “forever,” then you want a fullyamortized mortgage so you will eventually own the home free and clear with nomortgage.

However, if you plan to stay in the home less than 10 years,with an amortized mortgage you won’t accrue much principal paydown so you wouldbe better off cutting your monthly payment and paying just interest only.

As a long-time rental property investor, I loveinterest-only mortgages because they minimize monthly mortgage payments, makemy monthly interest-only payments fully tax deductible, and increase my cashflow.

Years ago, my banker told me banks also love interest-onlymortgages because they keep the bank’s money working full-time and they don’thave to be concerned about reinvesting principal payments.

To summarize, if you plan to stay in your home over 10years, you probably should obtain an amortized 30-year mortgage because theinterest rate is usually lower than for a so-called “optionmortgage.” But if you expect to keep your home less than 10 years, aninterest-only option mortgage will minimize your monthly payments and makethose payments 100 percent tax deductible.

The new Robert Bruss special report, “Pros and Cons ofFast and Slow House Flipping for Big Profits,” is now available for $5from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at1-800-736-1736 or instant Internet delivery at Questions for this columnare welcome at either address.

(For more information on Bob Bruss publications, visit his
Real Estate Center

Copyright 2006 Inman News

To search and research real estate data for more than 130 million properties nationwide, sign up for a FREE trial to RealtyTrac.

For the latest real estate news and trends get a FREE issue of our award-winning real estate newsletter, the Housing News Report.

Related Posts

Leave a Reply

Copyright © 2018 Renwood RealtyTrac LLC - All rights reserved