Trying To Avoid Paying Capital Gains Tax Same Year Of Sale.
Hello,
I am trying to figure out how to avoid paying the capital gains taxes in the year of sale.
I am planning on selling my properties with a land contract. The length is 2 years.
I have been reading contradictory responses regarding dealer status and different ways to get around some of the tax laws. I would definately prefer to pay the taxes after my buyers get financing.
Does anyone have suggestions on how to avoid paying the capital gains taxes the year the contract is made?
Will the IRS follow up on who is claiming tax write offs on what property?
Would there be problems if I allowed my buyers to claim the taxes and I wait to pay the cap. gains tax until my buyers pay off the contract?
Thanks for your time,
Wes
Tell us a little more background information first.
When did you buy each property?
What have you been doing with each property since you bought it?
Also do you fit into either one of these categories?
more than one-half of the personal services he or she performs in trades or businesses during the taxable year are performed in real property trades or businesses in which he or she materially participates, and
he or she performs more than 750 hours of services during the taxable year in real property trades or businesses in which he or she materially participates.
Real estate professionals include those individuals involved in construction, development, acquisition, conversion, rental operation, managing, leasing, and brokering.
I think you're already deferring much of your taxable gain via the installment sale method. If you receive at least one payment after the year of the sale then with an installment sale, such as a land contract, you only pay taxes on the gain as you receive the profits.
So, if you sell the property at a contract price of $100k and your cost basis is $80k, then pay on the $20k profit as you receive the payments. If you receive a $10k downpayment then 20% (20/100)of that pmt (or $2k) is gain.
Then, let's say in the second year you receive $8k in payments with $5k of it being interest. Therefore, you're only counting the $3k in principal payments towards your gain. Since your gross profit percentage is 20% then, 20% of the $3k in payments (or $600) is as gain in the 2nd year.
Make sense?
See irs pub#537 for the details.
Erick,
That info is golden!
The moderator for the board should put some flames on this thread.
Thank you,
Wes Laney
I went to a conference about a month ago and the speaker was Jay Mitton. He spoke on asset protection and taxes. He spoke quite a bit about avoiding capital gains. You can do this by forming a charitable remainder trust (CRT).
Talk to your attorney & accountant before doing this, but this is how it works:
Take all of your income and deposit it in a CRT (which is gaining income) legally you can withdrawal up to 90% of that for whatever you wish (put back into your pocket). The remaining 10% goes to a charity of your choice. You can give it to them immediately or after you pass on.
A real life example of this is, Bill Gates of Microsoft. He takes all of Microsoft’s income and places it in a CRT, withdrawals 90% (which goes back to the corporation). The remaining 10% goes to of all charities, "The Bill & Melinda Gates Foundation". Since Bill Gates is the President of the charity he of course gets paid a nice annual salary of $1 million.
Let me know what you decide to do.
Jorgan Cattin
Quote:That info is golden!
The moderator for the board should put some flames on this thread.Wes,
Before you get too excited, Erick's response does not apply in all situations. You need to answer the other questions you were asked first, before you get a definitive answer.
Because we don't have all the facts, you may be misinformed, although by well-intentioned people. I suggest that you take your tax questions to a licensed tax professional in your area and get specific details from someone you can hold liable if the advice is wrong.
DaveT,
I'm thirsty for info as to how my comments may not apply. Do you just mean that he'll have to be careful to make sure he does things correctly or is somehow installment sale treatment not allowed in this case.
Thanks for keeping me honest.
Erick,
The problem is that Wes did not tell us how long he has held the property nor how he used the property during his holding period. Installment sale tax treatment only applies to investment property, and is not allowed for dealer realty.
Additionally, if Wes is a real estate professional for tax purposes AND if he has been treating his passive losses as active losses to gain relief from the $25K passive loss limitation, then the profit on the sale of his property is also active income which may be fully taxable in the year of sale. In a Contract for Deed, the year of sale is the year in which the buyer and seller enter the contract.
Since Wes has not answered the basic questions we asked, we can't determine if an installment sale tax treatment would be allowed.
Dave,
I am purchasing properties the traditional way (i know, not very creative) and properties with John Lockes sub2 method.
I just wanted to know what is out there as far as getting around taxes etc.
So, I will:
1) Buy
2) Sell ASAP with LC
3) After two years, the buyers re-finance
4) I plan on giving the people who buy my properties the tax write offs.
Thanks for your time,
Wes
By the way, thanks for all of the responses everyone!
Wes,
I suspected that might be the case. In your situation, you fall into the dealer realty scenario. Your sales are dealer dispositions with all of the profit taxed in the year of the sale. You are not allowed to take installment sale tax treatment even though you use an installment sale.
Of course, because you pay tax on your profits up front, any return of principle in your buyer's monthly payments is tax free. Only the interest component of your buyer's monthly payment is taxable income to you.
Because self-employment income taxes may also apply, it is best if you consult a licensed tax professional for specific details.
As far as the tax write-offs for property taxes and mortgage interest are concerned, your buyers may be entitled to them. Best to have a conversation with your tax advisor on this topic as well.
Dave,
So you are saying that Ericks post regarding the IRS publication is incorrect?
Wes
Not incorrect, but the application is limited to property held for passive income or for long term appreciation. It does not apply to your situation because you are engaged in an active income activity.
Installment sale tax treatment does not apply to dealer realty. From your description of your investment approach, you are acting as a dealer to real estate. Ordinary income tax rates apply to your profits and self-employment taxes may apply to your net income.
Consult a licensed tax professional for specific details.
You might consider a different selling strategy for your properties. What we do is do lease-options. I suggest you read up on dealer vs. investor but a lot of what determines the difference is how well you demonstrate what you are. What I mean is that the longer you hold the property as an investor and treat it as a rental, the more you look like an investor. With lease-options the people are renting it but they also have the exclusive option to buy the property. I believe it's important that the option term be less than 3 yrs.
You have not sold the property when you lease/option it to them and when or if they do buy, you shall have held it for investment purposes.
Not to mention you'll have made some cash flow, received an option fee, been able to take depreciation, etc. and you could qualify for long term tax treatment at some point.
I'm not sure but a lease-purchase agreement may also provide the same tax advantages.
Erick,
Be careful here too. A pattern of consistently "selling" recently acquired property with a lease option technique is also acting as a dealer to real estate.
The problem for the real estate entrepreneur with your approach, is that it takes a few deals to establish a "pattern", and may take the IRS a few years to identity the pattern. When they do, a huge tax bill could be waiting for the taxpayer.
Don't take what I just said as an absolute indictment of all lease option deals as dealer dispositions. They aren't. It is when the taxpayer always seems to sell his properties, rarely keeping some for the long term production of income, that the taxpayer forms a pattern of dealer dispositions by lease option.
And, since a lease purchase creates an obligation for the tenant-buyer to complete the purchase (different from just the right to buy with a lease option), the seller should have an even higher sales rate than a typical lease option seller. So, my warning is even more emphatic if the exit strategy is the lease purchase route.