I’ve recently had to blow the dust off a conversation I used to have with Minneapolis and St Paul duplex sellers long ago.
The topic? Capital gains tax and depreciation recapture.
It’s a conversation I haven’t had since the market crashed in 2007.
Duplex owners, even those who owner-occupy, must treat the rental portions of their properties like a business. As such, that portion of the building may be subject to taxes when the property is sold.
Is there a way around this?
Yes. Sellers may choose to do what’s known as a 1031 or Starker Exchange.
This allows you to trade the proceeds of your sale into another property. This may be another multifamily property, or it could also be something like farmland, or a single-family rental property anywhere in the country.
Many people understand the principle of the exchange, but make the mistake of putting the proceeds of the sale in their bank account with the intention of buying something else with that money.
Unfortunately, doing an exchange that way is a taxable event.
In order to conform with the IRS‘s guidelines, the money from the sale of your rental property must be placed in the hands of a qualified intermediary. That entity holds the money, then releases it to the title company where you close on the sale of your replacement property.
As you go through the process of preparing to put your duplex on the market, it’s as important to have a conversation with your tax professional as it is to have your leases in order.
Not doing so could cost you a lot of money.