When 'Sally' Sells Soho

Published on May 8, 2017

When ‘Sally’ Sells Soho, She Safely Can Trim Her Taxes.

The Wall Street Journal recently wrote that actress Meg Ryan, of “You’ve Got Mail,” and “When Harry Met Sally,” both set in New York City, is selling her loft condominium in the Soho neighborhood for $10 million, having purchased it a decade earlier for $7 million.[1]

Her expected gain on the sale ($3 million) dwarfs the amount you can exclude from the sale of a principal residence ($250 thousand). In Manhattan, the tax on a $2,750,000 capital gain approaches forty percent (40%) in combined federal, state and city taxes. That would be over $1 million in taxes!

Could this “All-American Girl Next Door” do better on her taxes? Of course she can! But, as we will see below, it will require at least two (2) years of careful planning, in order to do so safely.

From Ms. Taylor’s reporting, we know that Ms. Ryan’s Soho loft occupied the entire fifth floor of its building, with over 4000 square feet (s.f.) of living area. In addition to her bedroom and bath, the loft had a large media room, two guest rooms, gourmet kitchen, and extensive cabinets and built-in shelving for books or decorative arts (awards?), throughout.

We can further suppose that with a little effort, it might be possible to reduce the “personal” portion of the loft to 1000 s.f., enough for bedroom, bath and kitchen, and to use the rest of the space for “business.” What counts as “business use” for an A-list Hollywood actress? I’d argue for the media room, an office, a study, a library, and other rooms used for meeting with and entertaining business guests.

IRS Revenue Procedure 2005-14, permits Ms. Ryan to split the sale of her loft into two (2) transactions:

(a) A sale of the principal residence portion (1,000 out of 4,000 s.f., or ¼ of the property) for $2,500,000, with a basis of $1,750,000, for a total gain of $750,000, and a taxable gain, after the $250,000 gain exclusion of $500,000.

(b) An exchange of the “business” portion of the property into other business or investment property, provided that Ms. Ryan finds at least $7,500,000 to acquire within 180 days of the closing of the sale of the Soho loft. This can avoid all tax on the “business” portion of the transaction.

The bottom line is that the only tax Ms. Ryan will pay is on the net taxable capital gain on the personal residence portion of her property, or $500,000 x .40 = $200,000. That’s not a bad result, to save almost $1,000,000 in tax, but could we do even better?

Some good accounting work or skillful negotiations could increase the basis of the kitchen, bedroom and bath for fix-up costs, or reduce the sales price of the personal portion, in order to accommodate a buyer, or to allocate fix-up costs Ms. Ryan had incurred over the years. With $250,000 of these adjustments, the capital gains tax could be reduced to $100,000. With $500,000 in such tweaks, the tax is eliminated.

This sort of planning typically requires professional help. There are special rules regarding the documentation of the exchange, and the business use of the portion of the property to be used in the exchange. You should plan and document this transaction as though the IRS Commissioner is your nosy next door neighbor.

The IRS regulations require that the business areas of a home be used “exclusively for business.” What if Meg’s use of her loft has blurred those lines? Remember I said two (2) years of careful planning was required? Here’s how that works.

IRS Revenue Procedure 2008-16 provides that property used as a personal residence can be converted to business or investment use through at least two (2) years of qualifying use prior to the date of the exchange. Therefore, even a property which was previously used entirely for personal use could be converted to 100% business or investment use, or, as in the example with Meg Ryan, some lesser percentage of business use, through careful planning and documentation prior to the date of the closing.

In other words, the IRS has given taxpayers both:

(a) A safe harbor to demonstrate that their property qualifies for a Section 1031 exchange, and

(b) A safe harbor to safely sell and exchange, in a single transaction, a property that allows both gain exclusion as a personal residence, and gain deferral under Section 1031.

If the safe harbors are met, IRS has said it will not challenge the tax savings.

Even better, the rules clarify, in an unusual concession for the IRS, that Meg can put all of the cash from the principal residence portion of the closing ($2,500,000, remember) into her pocket without increasing her tax, unlike the usual “boot” rule for partial Section 1031 exchanges.

That’s the sort of friendly behavior, from even a very nosy neighbor, that might be rewarded with a pie or cake once in a while.

[1] Some of the numbers reported by Journal‘s Candace Taylor have been adjusted to simplify calculations.

[2] Not intended to be legal advice, which is provided to our clients by written agreement only.

Caught in a Bad Romance?: The Transitional Estate Plan in 5 Steps

Published on April 13, 2017

Stress is a killer. Very few events in life create more stress than a bad marriage heading toward divorce. Heart disease, stroke, psychological problems, substance abuse, accidents, even suicide attend the soon-to-be-divorced at this critical crossroad. This article is designed to help assure that disastrously bad estate planning is never a cause, nor a result, of these tense times.

Here are the Steps to take:

Gather Your Records. Make sure you have copies (or, better, originals) of all of your crucial documents: Wills, trusts, powers of attorney, marital agreements, bank records, insurance policies, business and tax records, securities and other financial accounts, retirement benefit accounts, and the electronic passwords necessary for access to any electronically-stored records. Make an electronic backup copy of all your records and keep it in a safe location.
Contact and/or Meet with Your Attorney. (This should be an attorney who does not have a conflict from representation of your "ex." Sorry - I have learned from sad experience that sometime I need to point out the obvious to the highly emotional and distraught.) Bring all of the records you have gathered in Step 1 and give your attorney a copy. If you have a prenuptial or postnuptial agreement, make sure to discuss this first. Develop a plan that will (a) not violate any legal requirements while you are married, such as the "elective share," the ERISA retirement account rules, or obligations under marital agreements, and (b) protect your assets and accounts from unauthorized access or transfer during your lifetime, or transfer to the "wrong" beneficiaries after your death. This will typically require (1) amendments to any wills, trusts, and powers of attorney you may have, (2) careful review of all jointly-held assets and (3) amendment of beneficiary designations. Recent U.S. Supreme Court cases make it clear that if you don't change your beneficiary designations of important assets from your ex's name, the courts will not do it for you.
Contact and/or Meet with Your CPA. (Again, make sure your CPA doesn't have a conflict from a relationship with the "ex.") Often clients fall behind in their tax and other compliance requirements at this terrible time. Depression is the enemy of careful and meticulous practices. Don't let this happen to you. Make sure your CPA knows what changes you are making and gives you the income tax advice you need at this juncture. It can make all the difference, and can help your family attorney make the best settlement of your case.
Contact and/or Meet with Your Financial Advisor. Your investment plans were probably set up under the assumption that your marriage would continue for the rest of your life. Well, guess what? That plan is now moot. Don't go driving down the financial highway of life in a vehicle with two flat tires. Now is the time to reassess your resources and goals, and redesign a plan that will probably, for a time, require more flexibility.
Keep Your Senses. For some clients, that might mean: "take a deep breath." Others might need medical or professional help to keep an even keel psychologically. Understand that this is normal. Even the best people have bad marriages, so don't beat yourself up. Even the most successful people in life have had divorces, so don't think this is the end. Remember Julie Andrews's line as Maria, the "problem postulant" from "The Sound of Music" - "When God closes a door, somewhere he opens a window." Things worked out just fine for her, after all looked lost. They will for you, too. Taking these five (5) steps, you will be able to relax more about your financial affairs, reduce your stress, and sleep easier.

To comment on this article, or for additional resources, contact Mr. Marsh here or at Rmarsh@marshlawfirm.com.