Complicated stuff. You asked:
A) Accept 12.5% investment, part of my primary home equity as an investment option, in exchange for proportional future growth. The money is NOT a debt but an investment option.
Is the money ($85,000) I received taxable?
e.g: Appraised Primary Residence SFR: $680,000
Mortgage balance: $450,000
Investment: $ 85,000 = 12.5%
A: A "gain" means that the value of a taxpayer's investment has increased in value. Whether or not you have a taxable gain
on the $85,000 depends on the proportionate difference between the adjusted basis of the property
on acquisition and the value on the date of the "investment."
Let's say that your property was worth $580,000 when you purchased and $680,000 on the date of investment. That's a 17% gain. Which means that 17% of $85,000 = $14,655 is taxable income
If you think of the investment as being 100% of your property's value, and you would be relinquishing all right, title and interest
to the investor on the date of the investment, it would be no different than a sale of the property. You would incur a gain, and it would be taxable, unless protected by the gain on sale of taxpayer's principal residence exemption. IRC 121.
Now, there is one little catch to all of this. Unless the investor is actually receiving a deed making the investor a tenant in common in the property with a proportionate interest in the property, then your proposed transaction
is nothing more than a disguised loan with a variable return
, based upon the property's value on the date of sale or repayment. The reason for this is that without the proportionate interest, the principal payment is secured by a deed of trust, there is a maximum repayment period, and a variable rate
return. In short, everything about the transaction is exactly the same as a loan, except that there is only one payment, and the interest rate is undetermined until the date of sale. I was asking, what would be growth income for which I need to pay capital gains. e.g: 10 years growth is $268,888 X 2 = $537,776.
a) SELL the house: If I paid the investor $268,888. Then, will my capital gains tax be on $ 537,776 or $ 268,888, when I sell the house.
A: The capital gain is on your share of the property. The investor is taxed on its proportionate gain.
b) SETTLE Investor without selling the house: Will my capital gains tax when I sell the house IN THE FUTURE, be $537,776 or $268,888.
A: When you receive the $85,000, you have "sold" a proportionate share of the property to the investor. When, you pay the investor back, you are repurchasing that proportionate share. There is no gain on a purchase, and so no tax on that portion of your payment. If you don't sell your share of the property, then you would have no gain at all.
Moreover, if you satisfy the IRC 121 exemption requirements (2 years occupancy as principal residence on the date of the $85,000 investment), you would only have a gain if you exceed the $250,000 exemption (reduced to the proportion of the property sold -- which in my example would be 17% X 250,000 = $43,103 -- meaning that you would have no taxable gain, because it would be covered by your proportionate tax exemption).
Hope this helps.