250K Capital Gains Exclusion

snipped-for-privacy@atlasmiami.com wrote:

I'm curious about this too.. Anyone know? I found this article online that deals with something similar.

is the excerpt from it. Anyone comment? However, there is another approach which you may want to consider. However, a strong caveat is in order: this approach has not been approved nor authorized by the IRS. Before l997, when Congress enacted the Tax Reform Act authorizing the up to $500,000 exclusion of gain, homeowners were subject to what was known as the "rollover". Under this approach, if you sold your principal residence, and within either two years before or after the date of the sale you purchased another property, you were able to defer any gain which you made on the sale. The gain was deducted from the sales price of the new house, so that your tax basis was lowered. Example: you purchased property for $40,000 and put in $25,000 worth of improvements. You sold the property for $300,000, and within two years had purchased another property worth at least $300,000. Although the new price was $300,000, since you had made a profit of $235,000 ($300,000

- 65,000), this profit was "rolled over" to the new house. Accordingly, the basis for tax purposes of the new $300,000 was still only $65,000. The tax theory for this was simple; you did not avoid tax, but only deferred it to a time when you ultimately sold your house. Then, assuming there were no other tax-saving devices available, you would have to pay all of the gain you made on all houses. However, many people found that although they purchased a new house, they were unable to sell their old one within the two year period. What did they do? They created a sub-chapter S corporation, and sold the property to their corporation for the full market price. This way, they deferred the tax on the sale, and when the subchapter S ultimately sold the property, its gain was relatively small. A subchapter S corporation gets its name from the section of the Tax Code permitting such corporations. Over-simplified, this is a legal entity that is taxed much like a partnership, in that profits are taxed to the shareholders and not to the corporation. In l983, an enterprising individual found himself in the situation where he had purchased a new house, but was not able to sell the old one within the two year period. Rather than despair -- and clearly rather than pay the capital gains tax on the profit he anticipated on the sale of his principle residence -- he decided to sell the house to a wholly-owned Subchapter S corporation that he had created. The IRS was asked to give its opinion. In a private letter ruling dated September 13, l983, the IRS wrote the following: ...we conclude that section 1034 would govern the... sale of your home to Corporation provided that both the "old residence" and "new residence" qualify as your principal residences. No gain would be recog-nized to you provided the sale met all of the quali-fications of section 1034 of the Code.

However, if the new residence is later sold and gain recognized, that gain will be recognized as ordinary income to the extent of the gain that would have been ordinary income were it not deferred upon this sale under section

1034 of the Code. (Private Letter Ruling, 83-50084) The IRS also stressed that under the facts of this case, the taxpayer had unsuccessfully attempted to sell his old residence before contemplating the sale of the Sub S Corporation. It must be emphasized that this was a private IRS letter ruling, directed to a particular person. According to the IRS, such letter rulings may not be used or cited as precedence. However, the law was still the law, and the thought process of the IRS did give us some helpful guidance in those days. It should also be pointed out that in l989, the IRS also issued a letter ruling on a similar topic, but this time stated that "no opinion is expressed as to whether the sale of Residence A to a corporation wholly-owned by Husband and Wife is a bona fide sale for purposes of section 1034 of the Code." (Letter Ruling 89-46021, August 18, l989.) Clearly, there is no roll-over in existence today. However, it would appear that if you cannot sell your house now, you should consider selling it to a sub-chapter S, and if you are challenged by the IRS, you can make the same analogy to the roll-over concept. Incidentally, in the l980's, we used the sub-chapter S as the vehicle to test this concept. Nowadays, you might want to consider creating a limited liability company (LLC)-- wholly owned by the same owners as currently own your house -- and transfer the property to that LLC. You will probably have to pay a recordation and transfer tax to the local government where your property is located. But again, this cost will be far less than the capital gains tax you may have to pay. You also have to change your homeowner's insurance policy and put it in the name of the corporation or the LLC. If you have a mortgage, discuss the situation with your lender in advance of the transaction. You do not want your lender to call the loan, exercising the so-called "due on sale" clause. Most lenders will be understanding -- provided you let them know in advance of the sale. Thus, one approach to defer payment of the capital gains tax is the sale of the old residence to a sub-S corporation or to a limited liability company. There are absolutely no guarantees that this technique will work, but it may be worth your exploring. You must, however, fully discuss this approach with your financial, tax and legal advisors before embarking on this route.

I don't specifically know. But it seems to me that one problem could be section 351 and 311. If you satisfy those statutes to the extent that the sale to the corporation (I'd think a C-corp is probably safer than S-corp) then you might be ok. The other problem is what happens after the property gets sold by the corporation? Presumably it will pay off the outstanding note, most of which should be tax free. But then what? If you dissolve the corporation the IRS might come in and try to colapse the transaction with the step-transaction doctrine. With that much money at stake, it seems to me that it would pay to get a tax lawyer to look into the law and regulations to see if and how to do this. Stu