How A Duplex Short Sale Can Force You To Pay Taxes On Your Vacation

Virgin Islands beachRemember when duplexes appreciated with such regularity that you could actually take out a Home Equity Line of Credit (HELOC) or refinance and pull out the extra equity?

For example, if you bought a duplex for $200,000 and it increased in value by $50,000, you could refinance into a loan in the $250,000 range.

For some, it was a great way to pay off credit card debt, buy additional property or finance a vacation.

Times have changed. 

Now, property values have plunged. Many sellers are lucky to have equity at all. Some even discover they owe more on the duplex than it’s worth.

And for those who have to sell, this results in a short sale. The property may now sell for less than the owner even paid for it.

Worse yet, that money that came out of the equity when it was worth more? Taxable. Because it was a gain.

Odds are, the duplex owner didn’t pay taxes on it at the time they used it. So, if the owner took $50,000 out of the equity line in the above scenario, that money represented a gain over the original purchase price. And the seller would owe capital gains tax on it; even if the duplex only sold for $180.000.

See equity and taxable gain don’t have anything in common.

Is there a solution? Possibly.

While many sellers help defer capital gains tax by using a 1031 Exchange, or find relief if she was an owner occupant of the duplex, it would seem there wouldn’t be a solution for an investor.

Enter the Zero Equity 1031 Exchange. Basically, you exchange the gain; even though there’s no cash on hand.

I imagine it would take some talent to find a property to exchange into. However, this does at least give investors a potential tax deferrment.