SELLING REAL ESTATE? CONCERNED ABOUT CAPITAL GAINS TAX? READ HERE

Jimmy owns a couple of income properties in now-trendy Venice. He bought them way back in undesirable days for $75,000. Each property is now worth $600,000. Jimmy is 58 years old. He thinks about selling off some of his holdings and traveling. But he has questions – he needs to know what are his taxable consequences. Are there ways of avoiding or deferring his tax obligations?

 One very simple answer: pay the tax, pocket the rest of your gain, and enjoy your money. Our government is doling it out more freely these days. For property sales transactions which conclude between May 6, 2003 and December 31, 2008, the capital gains tax rate has been reduced from 20 percent to 15 percent. For taxpayers in the lower brackets of 10 or 15 percent, the tax will only be five percent of the gain.

If you plan to sell, it’s in your best interested to do it by the 2008 deadline. As for what to do with your money, you have a number of options. Before taking any action, be sure to consult your financial advisor. Benny Kass, senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in  real estate observed that property options can include:

1. Sell and pay the tax: Assume Jimmy has depreciated the property by $30,000 over the years. His basis in the property will be $45,000 ($75,000 - $30,000). If he were to sell the property for $600,000, he will have made a profit of $555,000 ($600,000 - $45,000). This does not take into account other costs and expenses which may reduce his gain - fix-up costs, closing fees, and real estate commissions. For Federal tax purposes, Jimmy will owe Uncle Pat $83,250 (at the 15 percent rate), not including state taxes and other prizes.

When Jimmy’s done with the federal government, his bottom line (excluding state taxes and other expenses), will be approximately $516,750 in gross sales proceeds. Any remaining mortgage fees will have to be paid off at settlement.

2. Do a Like Kind exchange: under section 1031 of the Internal Revenue Code, Jimmy can exchange his property for another piece of property that will be equal to or more expensive than his current property, deferring his capital gains tax obligation along the way. Jimmy can purchase a replacement property for $600,000. However, since this is an exchange, his tax basis will be the basis of the relinquished property - i.e. $45,000.

There are strict rules applicable to 1031 exchanges. Net sales proceeds must be held by a neutral intermediary. Replacement properties must be identified within 45 days after the sale of the relinquished property. Title needs to be taken to the replacement property within 180 days after the sale of the relinquished property. 1031 exchanges are only if you want to continue on as a landlord and keep that income stream running in.

3. Installment Sale: Jimmy can defer - but not avoid - paying capital gains tax if he sells the property and carries back a mortgage. This is known as an "installment sale". Under this arrangement, you pay a portion of the capital gains tax as the moneys come in each year.

4. Donate the property to a charity – FYI, there are restrictions and limitations on such donations which Jimmy should fully understand before you decide to go this route.

5. Sell the property to a family member: Is the property worth keeping in the family? Jimmy can sell it to a family member, and carry back the financing. If he is concerned about estate tax issues, he can gift up to $11,000 per person per year on the outstanding balance of the moneys he is owed by his family on his property.

In layman’s terms - Jimmy sells the property for $600,000 to his children, and agree to carry back all of the purchase price. His lucky kids sign a promissory note in the amount of $600,000 - there will be a deed of trust (mortgage) on the property in this amount. If Jimmy’s two children now own the property and if Jimmy is married. He and his wife can gift back - tax free - $44,000 of the balance of the note each and every year. Thus, in the first year, the note balance will be reduced down to $556,000 ($600,000 - $44,000), and so on each and every year.