I bought an $180K house for my daughter to live in 8 years ago. She got married and moved. Now I want to sell. How do I avoid capital gains taxes?
Dear Big Move,
My wife and I purchased a second home in late 2016 for our daughter after she had been through a divorce. This house is located in Lubbock, Texas. She was paying over $1,000 a month to rent an apartment and we decided it would make more sense to invest in a house and have her help pay the mortgage instead of renting the apartment.
With our share of money for a good down payment, her share of the mortgage payment was less than the amount she was paying for the apartment rental. Three years after living in that house, she met another man, remarried, and moved out of the Lubbock house. My daughter and her husband rent a house in another small town in the same state.
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For the last four years we have rented the Lubbock house to another family member for six months out of each year; another daughter uses it from time to time, and we use it when traveling there for medical appointments. We now are considering selling this house and using the profits earned to possibly purchase the house they are renting.
The couple, our daughter and her second husband are what I would call “lower middle class” and are not in a financial position to purchase or build a home. My wife and I are retired and live comfortably, and are pretty well set financially. We purchased the Lubbock house, a new build, for $180,000. Comparable sales for houses in the Lubbock area are selling for $250,000.
The owner of the rental house in Silverton, Texas that my daughter and her husband are in has expressed an interest in selling the house, somewhere in the range of $105,000 to $115,000. This house is in serious need of plumbing replacement and other repairs, but the basic structure is sound. Of course we would need to get an appraisal to determine what it is worth before necessary repairs.
My wife and I would then own the Silverton house and then just rent it to my daughter and her husband. So my question is, how should we proceed, and minimize our costs, and specifically our taxes? We were told there is a way to defer capital gains tax on the Lubbock house with a like-kind property – would this be an option for us in our situation? Or is there another way?
We would appreciate any ideas and advice you might have to give.
Doting Father
Dear Father,
It is admirable that you wish to support your daughters not only financially, but also with an eye towards making sure you’re not being taken advantage of. You’re not sacrificing your wealth, but rather, finding an optimal solution for all parties involved, so kudos for that. Your daughter must be so grateful that you are looking out for her.
As for to how to minimize your taxes if and/or when you sell the former Lubbock property your daughter was renting from you, here are two ideas as suggested by Matthew Chancey, a certified financial planner and author of “Tax Alpha Solutions: Effective Tax Management Strategies For High-Net-Worth Investors.”
You can first consider a 1031 exchange. Essentially, when you sell an investment property, you have to pay taxes on the gain at the time of the sale, but there are federal tax guidelines that allow you to postpone paying that tax, if you reinvest the proceeds in a similar property. To be clear, you are not avoiding taxes, you’re just deferring them by undertaking a 1031 exchange.
But the problem is that “the rules state you have to exchange an amount equal to or greater than,” Chancey noted, “and since you are selling something at $250,000 and only need to buy the new property for $115,000, … to complete a successful 1031 you would have to find an additional property worth the difference of about $135,000.”
Opportunity zones
However, that means you might have to own multiple properties. So consider the fact that you might have to become a landlord to not just your daughter, but another renter too. Consider the legwork involved in being a landlord to a potential stranger — is this something you would be up for? They can, in theory, be more unpredictable than people you know.
Chancey’s second suggestion: Under Section 1400Z-1 of the federal tax code, you can invest your money and also defer taxes. “Opportunity zones” refer to a provision in the tax code that aims to encourage private-investment in communities that are struggling, according to the Economic Innovation Group. It was enacted by Congress in the Tax Cuts and Jobs Act of 2017.
Your capital gain — estimated $70,000, if you sold the $180,000 house for $250,000 — could be reinvested into a 1400Z Qualified Opportunity Zone Fund, which would be an investment vehicle. That would in effect defer how much tax you will have to pay on the gain, Chancey adds. You would then have money left over to pay for the Silverton house, plus repairs.
