TAX CONSEQUENCES OF SELLING A DOUBLE/DUPLEX COULD BE A NIGHTMARE

Owners of doubles and duplexes who occupy one of the units as their “principal residence” and rent out the other unit can be faced with one of the biggest tax nightmares if they dispose of this property without the proper advice. 

Today many people who can’t afford to purchase a single-family home as their principal residence” do the next best thing and that is to acquire a double or duplex.

This acquisition allows them the opportunity of owning versus renting, and the income from the rental unit can also help in the qualifying process when procuring financing for this purchase and in the monthly payment of the debt service.

The problem arises when the owners of this double or duplex decide to dispose of the property for whatever reason, such as a young married couple who now needs more space due to a growing family or just a need of a change from their current property into a single-family home. 

Most owners are not aware of the tax consequences they will be faced with on this transaction. The average consumer has heard that if they go from one “principal residence” and as long as their gain (profit) doesn’t exceed $500,000, there is no taxation.

This can be done once every 24 months under Section 121 of the Internal Revenue Code. One even has the opportunity not to reinvest back into another “principal residence” just take the money and run under this Section of the Code.

But the owners of the owner-occupied double or duplex also have been renting out the second unit and it’s not treated as a “principal residence” so it does not qualify for a total tax-deferment that we just spoke of.

Only the unit that was owner-occupied qualifies under Section 121 of the Internal Revenue Code. The other unit becomes taxable based on the gain (profit) at the time of disposition.

This big problem starts at the meeting of the minds between the seller (taxpayer) and buyer. Once both parties have reached a meeting of the minds, they have a legal binding contract for the most part.

At this point, most (sellers) have no idea of the tax consequence and have never consulted with their tax adviser regarding this transaction.

They continue through the transaction and decide in most cases that they want to go into a single-family home and more likely will procure additional financing and exhaust their entire savings to find out that come April 15, they owe a large tax liability which was triggered from the investment held unit of the double/duplex that was disposed of.

What a position to be in! This individual in most cases will have to borrow money to pay Uncle Sam come April 15, because they never got advice as to the taxation of the transaction.

It is the job of the real estate professional listing the property for sale? Although the real estate professional should be abreast of the situation, their duties do not include giving tax or legal advice. 

They should be aware of the possible problems at the time they list the property by knowing whether it’s all investment held or principal residence and investment held.

A smart real estate professional should alert their client of the possible tax consequences they can be faced with and recommend they get tax advice from their accountant or CPA as to how to best structure this transaction.

If the sellers (taxpayers) of the double or duplex decide they want to go back into something other than just a single-family home which they will treat as their principal residence, they can structure the transaction to be totally tax free and tax deferred on both the principal residence unit and the investment held unit.

This can be done with the use of a tax-deferred Exchange, real estate Exchange, deferred Exchange, or like-kind Exchangethey’re all one in the same.

Under Section 1031 of the Internal Revenue Code, taxpayers disposing of trade, business, or investment-held properties have an opportunity to defer federal and, in most cases, state income tax associated with the gain (profit) by structuring the transaction as an Exchange.

This does not mean that it will affect their current transaction or buyer. With the proper planning and the use of a qualified intermediary, this possible nightmare can be a very rewarding venture.

Today the taxpayer can sleep nights with the amending of Section 121 pertaining to the “principal residence” and with the new regulations pertaining to trade, business or investment-held properties under Section 1031

These guidelines, with the proper use of a “qualified intermediary” to quarterback the transaction together with the real estate professional, accountant and attorney of the taxpayer working together to accomplish this type of transaction.