Seller afraid of capital gains

15 Replies

Whats up BP fam,

I just got off the phone with a owner of a house I found while driving for dollars. She says she wants to sell but she is afraid of paying capital gains taxes because she was killed by them when selling a different property. So this is the reason she has just held on to this one after owning it for 40 yrs. She paid $2500 for it back then. 

Is there away around that or is she just stuck paying those no matter what. I know people do 1031 exchanges to avoid paying the taxes but that won't work for me as far as trying to wholesale it. Even if not for this deal but for future knowledge, how is it possible to avoid paying them?

Gary

I would be afraid as well.  

you asked "Even if not for this deal but for future knowledge, how is it possible to avoid paying them?"

I am no tax accountant but as far as i know there is no way to avoid paying taxes. 

There are ways to defer taxes, postpone taxes, and spread taxes out... but no way to not pay them as far as I know...  Unless you die and your children get them at a stepped up basis.  but that wont go over well telling her that... 

One way to spread taxes out is to buy it from her using owner financing this will help her pay taxes only on the money she gets each year from you in payments. 

 less of a tax bill each year...  

@Gary Alford

She cannot avoid them, but may be able to mitigate the total capital gains paid.   If she were to sell the house to you and then hold the mortgage, she could realize her capital gains over a period of 5-years (5-years in Canada, I think it is the same in the U.S.A.) rather than all in year one.   This will usually amount to less taxes paid overall.

This would be a good question for your accountant.

@Gary Alford

  she can avoid them she can defer them if this has been a rental.  if its owner occ and she has lived there 2 of last 5 years there would be NO tax.

installment sale she pays tax as she receives her income.

We had an old family friend in Chesapeake, VA, who had the same scenario, just cash-flowing and waiting to pass them on as his beneficiaries would inherit at the stepped-up basis. I hope to have the same problem with my properties one day, slowly getting there.

In United States, if the house is the owner's primary residence for at least 2 out of last 5 years, owner may be qualified to have tax exemption for first $250,000 gain (if owned by couple, $500,000)

Accountants can confirm these details.

Offer her $ 2500 , and tell her there wont be any capital gains .   Now tell the seller that taxes are a part of life , but if she kept records of all the improvements over the years I believe that goes against the gains

Interesting article on installment sales

If you’re selling a prime piece of real estate, you can probably get top dollar in today’s market. But it may be worthwhile to structure the deal so you receive payments over several years.

Strategy: Sell the property on the “installment sale” basis. As long as you receive payments from the buyer in two or more tax years, you don’t owe current tax on all of your gain in the year of sale.

Not only does this defer the tax, it may also reduce your overall tax bill on the gain.

Recent tax-law changes further encourage real estate sellers to use the installment-sale method.

Here’s the whole story: Under the installment sale rules, only a portion of the gain is taxable in the year in which you receive a payment. Also, the taxable portion on the sale qualifies for favorable capital gain treatment.

The current maximum federal income tax rate on long-term capital gains is 20% for taxpayers in the highest ordinary income tax bracket. How­­ever, most taxpayers will owe no more than 15% to the feds on long-term capital gains. For sales of depreciable real estate, a maximum federal rate of 25% applies to the portion of gain attributable to your depreciation deductions. In addition, a 3.8% Medicare surtax now applies to the lesser of “net investment income,”(NII) which includes most sales of rental real estate properties, or the amount by which your modified adjusted gross income (MAGI) exceeds a threshold of $250,000 for joint filers (or a MAGI of $200,000 for single filers). These figures are not indexed for inflation.

Thus, you could pay an effective tax rate of 23.8% (20% + 3.8%) or 28.8% (25% + 3.8%) on the sale of highly appreciated long-term capital gain property in 2015.

What is the taxable portion of the payment? It’s based on the “gross profit ratio.” Gross profit ratio is determined by dividing the gross profit from the real estate sale by the contract price.

Example: You acquired a parcel of commercially zoned land several years ago. It has an adjusted tax basis of $600,000. In 2015, you agree to sell the property for $1.5 million in five annual installments of $300,000 each with the first installment received in 2015. Because your gross profit is $900,000 ($1.5 million – $600,000), the taxable percentage of each installment payment is 60% ($900,000 divided by $1.5 million).

When you report the sale on your 2015 tax return, you’re only taxed on $180,000 of gain (60% of $300,000), reducing your exposure to the 20% capital gains rate and the 3.8% net investment income tax.

For simplicity, let’s say you save the 5% capital gains differential on $100,000 of income each year. That’s a tax savings of $25,000 (5% of $500,000)—well worth the wait.

Finally, watch out for a little-known tax trap. If the sales price of your property (other than farm property or personal property) exceeds $150,000, interest must be paid to the government on the deferred tax to the extent that your outstanding installment receivables exceed $5 million.

Tip: Keep an eye on the $5 million limit if you want to preserve tax deferral.

@Steven Hamilton II is awesome at tax

@Gary Alford

I spose it depends on what you are structuring as a "wholesaling" deal but there's a dozen ways 1031 can work for them even working with you.  The key's are looking at when and how deed actually passes and how to structure that.  The whole 1031 process is really one of assignment of contract rights and direct deeding.  

1031 can also work with installment sales depending on their situation.

No you do not always have to pay the tax.  There are ways to eliminate it entirely over time.

Steer them to an experienced qualfied intermediary and tax planner.  They have a lot of options.

It's really matter of whether they need/want cash now or not. They could definitely do a 1031 exchange, and I don't see how the fact that you are wholesaling it would make that a problem. But if they bought the place 40 years ago then they are probably no spring chicken. They may not be interested in buying a other property at this point. I'd try to get some more information about what their actual scenario is and run it by an accountant so you can both have realistic picture of what the potential tax would be. 

I'm assuming the place has been a rental and is worth much more than the $2500 (!) they bought it for. Even after paying their cap gains tax they would probably net a nice chunk of change. The problem is that people tend to look at what the house is "worth" in today's dollars and then feel ripped off by the amount that they would clear after taxes. The challenge for you is to reframe that into a comparison of what they PAID for the place vs what they could PROFIT now. 

If it's currently cash flowing and not providing hassle for them that may not be convincing enough. But if they are having issues (tenant/maintenance/etc) or if they could use an influx of cash they you may be able to sway them.

The big thing is if it is owner occupied or a rental.

If she has always lived there and her gain in under 250K(252,500 price) she will not owe tax under the current.  If she used it as a rental she may owe a recapture tax on part of her original basis.  If she has proceeds over 250K and significant capital expenses, it is worth going to a tax accountant to make sure it is handled correctly.

If it is a rental, she will need to use a 1031 to defer taxes entirely.  Or an installment sale will spread them out over the years.  The interest income will be taxed at normal rates - but the capital gains will be spread out as the principal is received.  

Well, installments a good, but you can always transfer the property into a Charitable Remainder Trust, then sell on installments and the tax liability is reduced further by the gifting through the trust that allows you to keep more of the gain, depending on you bracket. You may do some generation skipping too to beneficiaries, so get with a good estate attorney.

Not for this house unless it's at about 750K+. Easy way is to get an option, find a buyer, sell the option, have the seller agree to finance to the new buyer (not you), you can't assign an agreement to extend credit, she needs to do that with the new buyer. :)

@Gary Alford

I spose it depends on what you are structuring as a "wholesaling" deal but there's a dozen ways 1031 can work for them even working with you.  The key's are looking at when and how deed actually passes and how to structure that.  The whole 1031 process is really one of assignment of contract rights and direct deeding.

I wanted to clarify the above post.  It is not dependent on when the deed actually passes but when the benefits and burdens of ownership actually passes to the buyer.  For example, in many states, sellers can use a Land Contract or Contract for Deed.  In these cases, ownership passes immediately, but the deed or title to the property is not conveyed or transferred until the debt has been paid off.  The 1031 Exchange can still be utilized, but it is important to realize that it starts up front and not when the deed actually passes.

Thank you everyone for the great responses! It is a lot of good info being put out in this thread. This owner has had this property as a rental and haven't lived in it for over 20 yrs. She is interested in doing seller financing but want to wait to really talk it out because she has to get a shoulder replacement this week. She is 86 yrs old and still managing rentals but said she is tired of doing so.

It is crazy to think of being 86 yrs old and still managing tenants! I don't even plan on managing them now let alone being 86 yrs old.

Thanks again everyone!

 and any funds due them if she goes 86, seriously, you better clear this with the family, at least on the side. The old lady may get ticked if she thinks she is trusted to sell, so tread lightly. Explain you don't need them to approve the deal but you also don't want trouble from the heirs, if there are any. Most everyone has heirs in the woodwork, if not, it could be the state asking about market value ends up in a nursing home later on. They can look back 7 years on the distribution of assets. Dot the i's and cross the t's. I also like to get a witness at signing things, that she is in her right mind, not a big deal but it can be at that age.

Dealing with the elderly is like dealing on another planet, while not really a protected class, in reality they are. :)

Really good info here. Have a similar scenario but between family. 

Sister wants to buy from Mother and Other sister co-owners but they owned a rental property for over 30 years and so their accountant said they would have to pay capital gains on ENTIRE sale amount. 

We are talking about structuring an installment sale but not sure exactly how that would work. ie $320k sale price, $80k down and then $1k per month for 20 years. This would be split between the two of them so hopefully keep them in a lower tax bracket. Not sure how much this would benefit sellers and buyers wouldnt get interest write offs.

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