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We are a retired American couple, both over 60, living overseas.

We own a house in...
We are a retired American couple, both over 60, living overseas. We own a house in the in California (which has a state income tax) on which we owe about 350K, and Zillow says it is worth about 700k now, projected to increase in value over the next year by about 10%. The house has been rented for 3 years. We acquired it through a 1031 exchange for 670k. We had purchased the previous property for 282k and did not make any significant capital improvements. We live fine on just our pensions, and we have 270k in IRA accounts. Here comes the question: we would like to purchase a house in our adopted foreign country. What is the best way to do that, in terms of the tax bite. Cash out the IRA and pay cash? Sell the CA house and use that money? Or take out a mortgage, possibly using some of the IRA as the down payment? (We would have no other source for a down payment. Thanks.
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Answered in 1 minute by:
8/1/2013
Megan C
Megan C, Certified Public Accountant (CPA)
Category: Finance
Satisfied Customers: 16,593
Experience: Licensed CPA, CFE, CMA, CGMA who teaches accounting courses at Master's Level
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MyVirtualCPA :

Thank you for your question, and thanks for using JustAnswer.com

MyVirtualCPA :

Based on the figures that you have given us, it seems that your best option would be to sell the property in California. You would have a gain of $30,000 based on the Zillow estimate and would only have to pay 15-20% tax on that

MyVirtualCPA :

With your IRA you are paying tax at your normal rate, which could be higher. Plus, you will be paying tax on more income. With the sale of the house, you only pay tax on the gain, regardless of how much cash flow you recognize.

Customer:

can you please explain how you calculated my gain? also keep in mind that California will want their piece as well. thanks

MyVirtualCPA :

Your gain is the $670,000 of basis you have in the property, and then assume you sell for $700,000 - that's a $30,000 gain

Customer:

hmmmmm....... I was told that my basis would be the earlier property which I used to complete the 1031 exchange on.

MyVirtualCPA :

Did you give boot? I assumed that when you exchanged for $670 that you gave the property of $282 plus cash to make up the rest

MyVirtualCPA :

If not, then your basis is $282K and your gain is $418,000 - and your tax would be significant on that. In this case, it's better to get a mortgage in your foreign country and then use your IRA money as a down payment.

Customer:

Don't know what "give boot" boot means. I did use all of the cash from the first property as the down payment and financed the rest to pay for the current property

MyVirtualCPA :

Okay. Your gain is $418,000

MyVirtualCPA :

It's best to take an IRA withdrawal for the down payment, then get a mortgage for the property

Customer:

so what would have had to happen to make my basis 670? I am a little confused.

MyVirtualCPA :

Forget I said anything about that.

Customer:

If I had taken your first answer and flown with it I would have had a very expensive surprise at tax time.

Customer:

I am leaving now less confident than before I started.

MyVirtualCPA :

I'm sorry you feel that way. I assumed when you said (and this is your words) that you acquired the property in the exchange for $670,000.

MyVirtualCPA :

To me, that means that all the consideration you gave would be $670,000

MyVirtualCPA :

but you're saying you just swapped properties. You should say that you acquired the property for $282,000

Customer:

I am a lay person who does not probably know accountant jargon. When I say I acquired a property for X amount, I mean that was the cost. Both properties involved a down payment and a mortgage. The first house cost 282. I sold it for 420. Then I put all the cash from the first house into the down payment for the second house (through a 1031 exchange company--I never touched the cash). The remainder was in the form of a mortgage. So I do not understand why you believe I should say that I acquired the present property at 282. To me, that is a misstatement. I acquired the second (current) house for 670. I am happy to pay for your expertise once I feel clear about it.

MyVirtualCPA :

Okay. My answer to you is to take funds from your IRA for down payment on the property and secure a mortgage.

Customer:

I am sorry but that sweeping conclusion without an explanation in lay terms as to how and why you came to this conclusion does not leave me satisfied.

MyVirtualCPA :

I say this because you will owe the least amount of tax if you do it that way.

Customer:

or confident

MyVirtualCPA :

Your gain on the sale of your home would be considerable.

Customer:

I believe that you are sure of your answer. However, I am not confident that we have completely understood each other, and therefore I have zero idea whether to accept this as "the answer".

Customer:

I really need to understand the reasoning and the rules.

MyVirtualCPA :

You asked what would yield you the lowest tax burden. This would be the answer. Based on the additional information that you gave me about your 1031 exchange your gain would be different. The mortgage you took out is considered boot and adds to your basis in the house you acquired.

MyVirtualCPA :

So, you would have your $282,000 plus the amount of debt.

MyVirtualCPA :

So, your gain on the sale would be $700 less 282 less the mortgage you took out

MyVirtualCPA :

that would be your gain

MyVirtualCPA :

And you would owe 15% tax federal on this and another 10% to California

Customer:

thank you for explaining that the mortgage is "taking boot" and is added to my basis. NOW it makes sense. thanks. Just remember that we don't all know the lingo.

Customer:

I am trying to rate you but am unable to do so until you do something.

MyVirtualCPA :

There you should be able to do it now.

MyVirtualCPA :

Do you have any further questions?

Customer:

no, that will do it

Megan C
Megan C, Certified Public Accountant (CPA)
Category: Finance
Satisfied Customers: 16,593
Experience: Licensed CPA, CFE, CMA, CGMA who teaches accounting courses at Master's Level
Verified
Megan C and 87 other Finance Specialists are ready to help you
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Gina,

Thank you so much for your positive rating. It was a pleasure working with you today. Please come back and visit MyVirtualCPA for any of your tax, finance, or social security needs.
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Megan C
Megan C
Megan C, Certified Public Accountant (CPA)
Category: Finance
Satisfied Customers: 16,593
16,593 Satisfied Customers
Experience: Licensed CPA, CFE, CMA, CGMA who teaches accounting courses at Master's Level

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