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In this scenario there is no way to avoid capital gains tax. However you can arrange it to defer and reduce the tax.
You can do a partial 1031 (like kind exchange).
A like kind exchange is where you can exchange one investment type property for another of the same or similar type. so for example: you can sell a rental property and buy another using the 1031 exchange and defer taxes.
In your scenario, you are selling a rental property, but you are buying only some land that would presumably be held for investment. So in this instance you can only do a partial 1031 (the land of the rental property for the land held for investment).
When the son sells the rental home, he then buys the property from the father allocating the 1031 exchange. the father sells the property on a installment agreement. the installment agreement allows him to defer the capital gains for the life of the agreement.
1. For installment agreements between relatives, the seller must charge fair market rate interest of about 6%; and that interest is reported as short term gains in the year it is paid. Capital gains are taken as the monthly payments are made.
2. A like kind exchange has to be designated prior to the close of sale on the rental home; and you have to use a like kind exchange agent.
since this is a partial exchange involving the land portion only, the remaining percentage of the sale will attract capital gains tax and you will still have to pay 25% recapture tax on any accumulated depreciation on the rental property.
FYI: the father can avoid capital gains all together by not selling the land, but gifting it to the son.
I see you made a deposit, but have not yet accepted. YOu are entitled to followup befor or after accepting.
Did you have other questions about this scenario?
That is not correct.
lets look at this sell.
do you know how much the accumulated depreciation is? if not, can you tell me how long the home has been a rental?
Rental property purchased Sept 2006 for $86k and $14k spent for renovation in 2006. Property was depreciated for that years taxes and for 2007 also. 2008 $20k more spent on improvements. Son hopes to sell property for $250k which was suggested price from realtor. Son then wants to buy 6 acres of his dad's land for $120k to build a new home to live and turn his primary residence into a rental home. In this case the son will not have to pay capital gains but the dad will, correct?
Are there any suggestions on how both parties can come out good on taxes in this situation?
Thank you for your additional information.
I am going to give you the total tax liabiltiy (approximate) based on the information given for each scenario.
Fully Visible Transaction.
Rental Property sell:
Now the son's taxes if he does a partial exchange:
In doing a partial exchange, he has to apportion the cost of land to the original property. You can get this from the latested property tax record. I need to know the portion of the 86K that was land, and the portion of the 250,000 that is land.
ELSE I can just estimate it at 25%. Let me know
Rental property at purchase was house with 5 acres. House has been divided and surveyed with 0.5 acres. The land by itself is 4.5 acres. Son hopes to sell house for $150k and land for $100k. THanks for your assistance.
Thank you for the additional information.
So now, if he does a partial 1031 exchange, his taxes on the sell of the home looks like this:
Now this is very tough but should give you an idea of the differences. You can see that by doing a partial 1031 exchange for the land, he only pays half the tax. An actual exchange agent will have a different figure because he or she will be able to work with you to capture all the costs and precisely apportion the cost basis and depreciation.
The cost basis of the land is added to the cost basis of teh property he buys from you.
Use this calculator to determine how much you have o to invest in your land he busy from you. Use this calculator only for the land portion.