Page 14 - Old Republic Title Exchange

ANSWERS
TO YOUR QUESTIONS

Can I defer capital gains tax when I sell my primary residence? No. However, you can exclude up to
$250,000 of gain from taxation (or $500,000, if you are married) under IRC §121.
Caveat: If you originally acquired your residence as investment property, you must have owned it for a
total of five years and you must have resided in it for at least two of the last five years, in order to take
advantage of the $250,000/$500,000 exclusion.
Further, the normal $250,000 or $500,000 amount will be reduced based upon the prorated amount of
time the property was used for investment purposes.
If I sell an investment property that I previously used as a principal residence, can I exclude gain under
the §121 primary residence exclusion and defer investment gain under §1031? Yes. Revenue Procedure
2005-14 establishes the following rules for applying both sections:
1. §121 applied before §1031; and
2. Gain from depreciation may not be excluded under §121, but can be deferred under §1031; and
3. Boot will be taxed, but only to the extent it exceeds the §121 exclusion.

Can I exchange with a related party? You can exchange with a related party subject to certain
restrictions. If you buy your replacement property from a related party or swap with a related party,
the related party also must do an exchange and both of you must hold your replacement property for
two years. If you sell to a related party, the related party must hold the property for two years and you
must hold your replacement property for two years.
Caveat: If a related party transaction or series of transactions was designed to avoid the application of
the related party rules, the exchange will be disallowed.
Related parties include: brothers and sisters (whole or half blood), spouses, children, parents and any
other ancestors, any lineal descendents, and corporations or other business entities; in which you own
more than 50% either directly or indirectly through your family members. Related parties also include
certain fiduciary relationships described in IRC §267(b).
Do I have access to my money during the exchange? No. The Treasury Regulations governing
exchanges prohibit you from having actual or constructive receipt of the exchange funds during the
exchange period. Only if you fail to identify the replacement property in writing within the 45-day
identification period may you have your funds on the 46th day following your disposition. Otherwise,
you must wait until you complete your exchange or until the expiration of the 180-day exchange period
before you receive exchange funds. See Treasury Regulation 1.1031(k)-1(g)(6), commonly referred to as
the “g6” restrictions or limitations.
Exchange expenses: Exchange expenses are certain customary closing costs incurred in connection
with selling property that reduce the amount the taxpayer is required to reinvest because paying for
these costs reduces the taxpayer’s gain. The use of proceeds to pay some closing costs, however, may
result in boot. Revenue Ruling 72-456 provides that brokerage commissions reduce the taxpayer’s gain
and increase the basis of the replacement property. Technical Advice Memorandum 8328011 implies
that other transactional expenses should be allowed (i.e., reduce gain) if paid from the proceeds in
connection with the exchange. These allowable expenses are referred to as “exchange expenses” in IRS
Tax Form 8824, but are not specifically listed anywhere. Most tax practitioners consider the following
exchange expenses to be allowable for purposes of reducing realized gain and recognized gain: real
estate commissions, exchange fees, legal fees, title and escrow fees, and transfer taxes.

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