Strategy to Avoid Capital Gains Tax

9 Replies

Hello BP!

I've been kicking around a capital gains question for awhile, hoping to get some insight. To preface, I'm planning to cash out of a duplex I own in my personal name, either through a sale to my partner or on the open market. I haven't 100% determined which of those routes yet. My question is in regard to the capital gain I would realize in either scenario.

Essentially, I am looking to avoid paying capital gains tax, however, I'm not in a position to do a 1031. Unfortunately, I had a flip go sideways for me, and I'm carrying a lot of personal debt right now, incurred from getting that project to the finish line. So, avoiding capital gains tax on the disposition of this duplex would also go a long way in helping relieve some of that debt, as well.

In trying to figure a way to avoid the tax, outside of a 1031, I've been thinking about a particular strategy. It looks like the current long term capital gain tax bracket allows for a 0% rate if a single filer makes less than $40,000 yearly. I don't make much at my W2 job; I really just have it for the W2. I usually do gross less than that. Now, in 2020, when combining my W2 and rental income from that property, I've gone over that $40,000 threshold. So, my thinking is, regardless of how I exit the property, to close in 2021. Without the rental income, and as long as I don't earn more than $40,000 personally next year, I wouldn't have to pay tax on that gain. Is that logic correct?

I also do plan to buy at least one, perhaps two, properties in 2021. Could those be planned so that any rental income is offset by the losses I could claim, effectively keeping my income below that $40,000? Moving forward, I plan to hold those in my LLC actually anyway, so I'd have any rental payments made to that LLC. Perhaps as long as I don't draw any profit from that into my personal name until 2022, that would also be a viable way to shield my personal income and keep it below the 0% capital gains tax threshold.

Does the way I'm thinking through this strategy sound feasible? Any insight is appreciated!

I think you misunderstand what goes in the Capital Gains Tax bucket and what goes in the ordinary income tax bucket. Please go consult with a CPA or Tax Lawyer.

Good Luck !!!

Hello Brian!

Thank you for responding. I have also reached out to my accountant, just awaiting him to get back. Just figured I'd get some insight on here, as well. Is it essentially that capital gains isn't taxation related to ordinary income taxation; you can't base what you may or may not get taxed in capital gains off of personal income?

Capital Gains on a property will be treated as one bucket of income; then your W2 job is another bucket. And we are going into some detail here, but, the Real Estate investment profit and losses will not be counted against your W2 income if you are not "active" in the real estate business. The IRS has stated rather clearly, that if you are a full time employee of someone receiving a W2, then your investment income or losses will be treated as Passive and not deductible against your ordinary income. Please go speak with your accountant on this topic. What you are suggesting above strikes me as an audit flag from the IRS.

Good Luck!

@Mikael Winkler

Let your accountant demystify this.  You've got at least earned income, capital gains, and passive income all in play.  They are separate types of income that are treated differently/separately.

Also, you mentioned a "...flip go sideways for me..."  Well, flips are taxed as ordinary income.  While it depends technically on your circumstances, generally they are ordinary income and not passive income or even capital gains.  That's why flipping isn't really investing and some don't like it since you have to pay tax at your marginal tax rate as well as self employment tax.  I realize you said it was a loss, but you should realize that it is most likely correctly NOT treated as passive or capital gain type income/loss.

Good luck.

Thank you both for the additional responses. After some more in-depth research, I realize that this is a more complex situation, as you both alluded to. While I'm awaiting further clarification from my CPA, I do see that these are separate income forms, and the capital gains tax brackets are not a black and white "if you make below x, you pay y%". That's essentially how I was viewing it. I also now see that the capital gain is layered on top of one's ordinary taxable income, which pretty much explodes the theory I had haha.

More in-depth planning with my accountant is warranted. Thanks again, to both of you!

@Mikael Winkler

It is not as simple as saying you make below $40,000 and your capital gains is taxed at 0%.
You also have to include the capital gains to the calculation when factoring if you are below or above $40,000.

Also a 1031 exchange may not be an option for a "flip".

@Basit Siddiqi

With this relatively new tax code, is the capital gains a “marginal system?”  In the case where you had ONlY capital gains, would the first $40k be taxed at zero? Or if you had more than $40k it would all be taxed at 15%?  Thanks

Originally posted by @Mikael Winkler :

Hello BP!

I've been kicking around a capital gains question for awhile, hoping to get some insight. To preface, I'm planning to cash out of a duplex I own in my personal name, either through a sale to my partner or on the open market. I haven't 100% determined which of those routes yet. My question is in regard to the capital gain I would realize in either scenario.

Essentially, I am looking to avoid paying capital gains tax, however, I'm not in a position to do a 1031. Unfortunately, I had a flip go sideways for me, and I'm carrying a lot of personal debt right now, incurred from getting that project to the finish line. So, avoiding capital gains tax on the disposition of this duplex would also go a long way in helping relieve some of that debt, as well.

In trying to figure a way to avoid the tax, outside of a 1031, I've been thinking about a particular strategy. It looks like the current long term capital gain tax bracket allows for a 0% rate if a single filer makes less than $40,000 yearly. I don't make much at my W2 job; I really just have it for the W2. I usually do gross less than that. Now, in 2020, when combining my W2 and rental income from that property, I've gone over that $40,000 threshold. So, my thinking is, regardless of how I exit the property, to close in 2021. Without the rental income, and as long as I don't earn more than $40,000 personally next year, I wouldn't have to pay tax on that gain. Is that logic correct?

I also do plan to buy at least one, perhaps two, properties in 2021. Could those be planned so that any rental income is offset by the losses I could claim, effectively keeping my income below that $40,000? Moving forward, I plan to hold those in my LLC actually anyway, so I'd have any rental payments made to that LLC. Perhaps as long as I don't draw any profit from that into my personal name until 2022, that would also be a viable way to shield my personal income and keep it below the 0% capital gains tax threshold.

Does the way I'm thinking through this strategy sound feasible? Any insight is appreciated!

 I think this can be planned. You are right on few things.

1) your cap gain gets stacked up with your W2 income and other income. 
2) if you have some rental loss, yes it can decrease your initial 40k other/W2 income.

Quick call to CPA should clarify. Feel free to DM me. 

Thank you all for the responses. @Basit Siddiqi hit the nail on the head with how I was thinking about capital gains. I was thinking it was a straightforward "if you make x, you're taxed at y%" (wish it was!). I have done further digging and now more fully understand how it actually works. Unless I made zero dollars and realized a capital gain of less than $40,000, the gain stacks on top of my W2. Thus, the vast majority of it will be taxed at 15%. Nothing is ever simple with taxes!