Strategies to reduce, defer, or eliminate taxable
gain on sale
of real estate
1.
A sction 1031 exchange:
Briefly stated, a 1031 exchange is a transaction that allows
one to defer taxes on the disposition of property by exchanging
property for property. The transaction must meet certain
IRS requirements and the property must be for business use
or held for investment. Some think that these exchanges
are only between two owners. While this is possible, it
is also possible that there are three-way (or more) exchanges.
When property is exchanged for another piece of property,
the untaxed gain rolls over into the newly acquired property.
This is called “deferred gain”. Many investors
and property owners like this method, because they can defer
most or all gains until death. Then, their heirs will receive
a “step- up” basis in the property and the deferred
gain disappears. One of the requirements for this type exchange
is that the properties must be “like-kind”.
While this seems to indicate a limitation, there are a diversity
of types of properties and combinations that can be used.
These include, but are not limited to, rental houses, condos,
duplexes, apartment buildings, land, trailer parks, shopping
centers, retail stores, office buildings, motels, hotels,
parking lots, golf courses, ranches, farms, warehouses,
plants and factories, storage facilities and certain time
shares. Related party transactions may also be allowed if
the property meets certain requirements.
2.
Installament Sale (Seller Financing):
This method allows the seller to defer the capital-gains
tax, but it will not defer depreciation recapture.
Instead of receiving cash from the sale of property, the
seller can hold part of the selling price as a mortgage
(or deed of trust). One advantage of the installment sale,
other than deferment of taxes, is that the seller may be
able to earn a better interest rate than could be earned
in the market if a 100% cash sale took place. You would
actually be earning interest income on the deferred income
tax liability. Good advice would be to make sure you receive
a sizable down payment (enough to cover all of the taxes
due in the year of sale) and that the purchaser is of good
financial condition. If the purchaser’s financial
condition is doubtful, request additional collateral to
secure the loan.
3.
Refinance rather than sell:
If you have property that has a positive cash flow, not
causing any major problems, and is expected to appreciate
in value each year, then keep it. Consider a cash-out refinance
of the property to get the cash you need for financial purposes
and investments. The cash received from the new mortgage
is tax-free.
4.
Hold until death:
Death will totally eliminate all income taxes on the appreciated
gain. In addition, the heir will receive a stepped-up basis
upon death. This strategy is also a great estate-planning
tool.
5.
Look for losses or deductions to reduce taxable gain:
Review all your asset holdings and consider selling them
before year-end to off set taxable gain. These may be poorly
performing stocks or bonds. If you sell these assets it
will create capital losses and they can be used to fully
offset capital gains. Also a business loss, retirement plan
contribution, and many other deductions can do the same.
6.
Charitable Remainder Trust (CRT)
With CRTs one transfers appreciated property (real estate,
stocks, mutual funds, etc.) to the trust in exchange for
an income stream over his or her lifetime. This transfer
is not a taxable event. The trust will sell the property,
tax free, to an outside buyer. The trust reinvests the proceeds
from the sale to help fund the income stream back to the
donor. The CRT is ideal for someone that has a sizable estate
and does not want his or her heirs to receive these assets
(or does not have any), since the assets of the trust will
eventually go to the charity. CRTs also save estate taxes
and reap an immediate charitable deduction.
In closing, these are probably the most popular strategies
to reduce, defer, or eliminated taxable gain on the sale
of business or investment property. They are in no way the
only methods. You should always seek good counseling before
the sale of any property you own. Congress is constantly
making changes to our already complex tax system. DBJ
(Joel
Cunnigham is a Certified Public Accountant in Belzoni, MS.)
