The current economic environment is certainly not the best time to sell a piece of investment real estate, but personal circumstances might dictate that you must sell right now. What are your options as it relates to paying the capital gains tax you will incur on the sale?
Too often, I will get a call from a real estate investor telling me they just sold a property and are worried about paying too much in taxes. After a closing, there is almost nothing even the smartest tax advisor can do to minimize the taxes. BUT…
If you call prior to the sale of the property, you will have options as it relates to the tax effect of the sale.
This is what most people do, mostly by default. They do not get good advice up front so they are stuck with this option. Assuming the property was held for business or investment purposes and was held for over one year, you may have to recapture depreciation taken at 25% and pay capital gains taxes at 15% (the capital gains rate for 2010, expected to rise in 2011 to 20%.)
An installment sale involves the seller holding a first or second mortgage on the property sold. By doing this, the seller only pays taxes on the amount of dollars received and defers the taxes due on the portion of the selling price that represents the mortgage held on the property. As mortgage payments are received, a portion of the mortgage payment will be subject to capital gains taxes in the year the payment is received.
This option allows you to potentially defer all taxes due on the sale of a property if the proceeds of the sale are reinvested into another property, whether you manage that property or not. This is a great strategy for someone who wants to sell to get rid of the hassles of managing the property. However, there are specific rules that must be followed, so consult an experienced real estate CPA.
Ted Lanzaro is a regular guest speaker at CT REIA. Go here for the current list of upcoming real estate investing seminars in Connecticut.
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