There are four more basic methods to consider when trying to avoid paying capital gains tax on the sale of your home.
METHOD #4 – INSTALLMENT SALES. Home sellers and realty investors often forget about this method of selling real estate without paying capital gains taxes (or at least deferring those taxes far into the future, or maybe never!). When a personal residence or investment property is owned free and clear without any mortgage, the seller is in an ideal situation to sell and carry back the mortgage financing for the buyer.
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Offering easy financing is a great way for a property seller to get top dollar for the property. Equally important, the seller will then receive installment-sale income. If the seller doesn’t want to pay any capital gains taxes on the installment sale (which must be spread out with payments received in at least two tax years), secured by a first or second mortgage on the property sold, the installment-sale promissory note can be structured to be “interest only” payments from the buyer to the seller. That’s good for the buyer who makes minimal tax-deductible monthly payments to the seller. Of course, the interest income received is taxable as ordinary income to the seller-mortgage holder.
If there are no principal payments made to the installment-sale seller (except a minimal $1 in the year of the property sale, plus the principal balance due in a future year), all the seller’s principal remains busy earning interest income with no work on the investor’s part (except depositing the monthly interest checks).
In today’s low-interest-rate economy, a property seller can easily earn 5 percent to 6 percent or higher interest income on installment sales with the security of a mortgage or deed of trust on the property sold. If the buyer doesn’t make the monthly payments, the seller can foreclose and either get paid in full at the foreclosure sale or get the property back to resell for a second profit.
If the property seller dies while still holding the installment-sale mortgage on which there were no or few principal payments made, the capital gains tax which would have been due is forgiven by Uncle Sam. Of course, the installment-sale mortgage becomes an asset in the estate of the deceased mortgage holder who avoided paying capital gains tax.
METHOD #5 – TAX-FREE INVESTING WITHIN YOUR ROTH I.R.A. A great way to create tax-free income during realty ownership without capital gains tax when selling a property is to invest in real estate within your Roth IRA. If you have a regular IRA, or another retirement plan such as a 401(k) or 403(b), you can often “rollover” those assets, paying the tax, into your Roth IRA where you can buy investment real estate within your tax-free Roth IRA.
To do this, the Roth IRA must be set up to be self-directed with a trustee who allows real estate investments. For more information, good Web sites include www.entrustadmin.com (Entrust Administration), www.Sterling-trust.com (Sterling Trust Services), and www.midoh.com (Mid Ohio Securities). Entrust has an extensive Web site with lots of valuable information.
METHOD #6 – PRIVATE ANNUITY TRUSTS. This is a rather sophisticated tax- and estate-planning device that definitely requires the assistance of an experienced trust attorney. The basic idea is to create a private annuity trust that will be funded with assets, such as appreciated real estate, which is then exchanged tax-deferred for a private annuity contract to pay income to the investor. If you don’t need immediate income, the annuity income can be deferred to age 70½.
No tax will be due until income is received, such as from a commercial annuity purchased with proceeds from the sale of the appreciated real estate. In addition to the income advantage, a private annuity trust reduces the investor’s taxable estate and no tax is due upon transfer of the property into the trust because the tax is deferred, similar to an installment sale. For more information, a good Web site is www.PrivateAnnuityTrusts.com.
METHOD #7 – CHARITABLE REMAINDER TRUSTS. Another method of deferring and eliminating capital gains tax is to create a charitable remainder trust to support a favorite worthwhile charity. Not all charities have established procedures to accept real estate donations, which usually provide lifetime use and/or income to the donor. Most large universities and major charitable organizations, such as the Salvation Army and the American Cancer Society, welcome charitable remainder-trust donations. The possible disadvantage is it is an irrevocable trust, so once the asset is donated, the donor can’t revoke the donation due to changed personal circumstances.
SUMMARY: These four significant methods are excellent ways for avoiding payment of capital gains tax when disposing of your personal residence and/or investment real estate. Depending on your wishes, you can also create tax-free or taxable income for yourself and your family. Or you can donate your real estate assets to a favorite charity while enjoying property benefits and income during your lifetime. For full details on avoiding capital gains taxes when selling your home or investment property, please consult your personal tax adviser.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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