If your office and home are located in the same building, the IRS has issued a new tax law interpretation ruling that allows you to exclude some or all of the gain when you sell your property and replace it with a similar property.
Let's assume that you own a building where your office is located on the first floor and you live on the second floor. You are now contemplating selling the property and purchasing a larger building, where you will also work and live. Assume that you paid $210,000 for your current property, one third of which is used for your office and two thirds for your home. You have taken $30,000 of depreciation deductions for the business portion of the currently owned building. You are going to pay $360,000 for a replacement building, one third of which will house your office and two thirds your private home.
The tax code allows you to exclude up to $250,000 ($500,000 if you are married) of gain on the sale of your primary residence according to International Residence Code (IRC) Section 121. According to IRC Section 1031 (often called a 1031 like-kind exchange), you can also defer the gain on the exchange of a business property for a like-kind property that will be used for your business or held for investment.
The IRS recently issued Revenue Procedure 2005- 14, effective Jan. 27, 2005, clarifying how to apply IRC Sections 121 and 1031 when you exchange a property you use as both a home and business location for a similar property that you likewise intend to use for both home and business. The following is how the above example plays out:
Running the Numbers
Under Section 121, you may exclude from taxation the $100,000 gain allocable to the residential portion of the building. $360,000 amount realized on exchange of properties x ? = $240,000 -$140,000 (ie, $210,000 basis in the current building x ?). The remaining gain of $80,000 is allocable to the business portion of the building. $360,000 amount realized x ? = $120,000 -$40,000 adjusted basis (ie, $210,000 original basis x ? = $70,000 -$30,000 original building depreciation). In calculating the nontaxable gain, Section 121 is applied before applying the nonrecognition rules of Section 1031.
Under the new revenue procedure, you can exclude $50,000 of the $80,000 gain on the business portion of the exchange. You are not permitted to exclude the $30,000 portion of the gain attributable to depreciation deductions, but you may defer this $30,000 gain under Section 1031.
Your new tax basis in the personal dwelling portion of the new building is $240,000. $140,000 original basis + $100,000 gain excluded from tax under Section 121. Your tax basis in the office portion of the new building is $90,000. $40,000 basis in original building + $50,000 gain excluded from taxation under Section 121. The net effect is that you will pay no tax on the exchange of the original property that you purchased for $210,000 in exchange for the new property with a fair market value of $360,000.
If you own a property that you are currently using as both an office and a home and you are contemplating relocating to a newer or larger property, you could save thousands of tax dollars by properly structuring the transaction to meet the requirements of Sections 121 and 1031. Talk to your accountant or tax advisor to see if you qualify for the new interpretation on exclusion rules for these types of transactions.
a licensed tax attorney, is president
of Alliance Affiliated Equities Corp, a
NASD-registered broker/dealer specializing in
tax-advantaged investments. He welcomes
questions or comments at 800-453-5155 or
David P. Dyer,