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Guest-host Leonard Baron, a real estate professor at San Diego State University and principal of LPB Services, a real estate consulting firm, tackles your real estate questions today as part of Savvy & Sage: Tips on Buying and Selling in 2009.

Question from firsttimebuyer:

I had to move out of the county in 2007 and so have been renting out my condo at $500 cash flow negative each month. I am now bumping up against the 5 year rule (live in it 2 of 5 years to claim capital gains exemption) and don’t know what to do. I can’t afford to oust the tenants to put it on the market, yet I need to sell it so I can move out of the rental I am in and buy in the area where I currently live. If I have to hang onto it past the 5 year rule, am I stuck to pay the taxes? I’ve heard of a rule that allows an “exchange” of the property but don’t know how it works or if it is available to people like me who own only one residence but don’t live in it.

Hi firsttimebuyer!

Yes, yes and yes. To your luck, I am in the process of a 1031 exchange right now!  If you go past the five year rule you still can defer (and possibly permanently similar to an exemption) any taxes owed. It is called a 1031 Starker exchange.

You can read all about them at IPX. (This is Chicago Title Company’s exchange company — Chicago Title is one of the largest title companies in the United States. Make sure you use one of the large national companies for your exchange — a couple of small company owners have absconded with money in the past … to the unfortunate loss of those people who trusted them.)

As a side note, you could also sell it with a renter in place before the five years is out. Plenty of investors would love to pick up a property that is already rented — especially if it comes with a twelve-month lease and good tenants. But there are some new IRS rules related to the 2/5 year issue and they are complex — so we would need to investigate further.

In your instance, since it is rental property, you can avoid being taxed if you sell your property and buy a new rental property (or properties) of equal to or greater value and roll ALL the net cash you received from the sale into acquiring the new property.   

You need to make sure, before you start the process to sell your first place, that you fully understand the 1031 rules and have all the legal and tax advice you need to make it work. Plus you need to already be making offers on the properties you plan to buy and hopefully correctly identify the ones you will close upon. If you don’t close on the ones you identify within 180 days….you are out of luck, your 1031 has failed, and the President may personally stop by to pick up the check you will be giving for the IRS.  

The only other kink is that the property you buy must be “like kind” so it must be a rental property. So buy the property you want, rent it out for one year to satisfy the IRS rules, and then move into it as your residence and voila. Make sure to have a good tax person advise you BEFORE you do anything!

If you have more questions for Leonard Baron, please leave a comment or send an e-mail to kelly.bennett@voiceofsandiego.org.

— LEONARD BARON

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