Capital Gains Tax Deferral on Real Estate
If you managed to buy property at the right time and are now looking to sell it in a booming real estate market, there is a possibility of significant financial gain. However, you are also looking at a significant tax burden – more than 33% in some states.
We hear from investors worldwide who are wondering how they can avoid capital gains tax when selling their investment property, rental property, inherited property, or primary residences. While there is no way to avoid taxes completely, there are a handful of ways we can help you in deferring (sometimes indefinitely) capital gains tax on your real estate. You are welcome to reach out and call us anytime, but in the meantime, let’s walk you through the basics.
Taxes on Real Estate
When you sell real estate–whether it is a primary residence, a rental property, an inherited home, or a multifamily investment property – the federal government considers the profit you make a capital gain.
Therefore, it is subject to capital gains taxes. Capital gains taxes fall into two categories, based on how long you’ve held your property.
Short-Term Capital Gains
The federal government considers any profit from an asset purchased and then sold in the same year a short-term investment, and it is subject to short-term capital gains taxes. Tax on short-term capital gains is the same as income tax, so you will pay between 10% – 37% in federal taxes based on your income bracket.
States can also levy a tax; in California, the top income bracket requires an additional 13.3%. Some people in the top tax bracket might also have to pay the Net Investment Income Tax (NIIT), which imposes an additional 3.8% tax. So if you bought a house for $500,000, renovated it, then sold it for $1.5 million in the same year, you could owe up to $541,000 in capital gains taxes on your million-dollar profit.
Long-Term Capital Gains
The simplest way to lower your capital gains taxes is to hold your property for over a year. The federal government wants to incentivize long-term investments.
Therefore, the taxes on assets held for over a year are lower than those on short-term investments. The taxes on long-term capital gains range from 0%-20%, depending on your income bracket.
Most (but not all) states also levy an additional capital gains tax. While long-term capital gains taxes are lower than the taxes on short-term capital gains, you could still end up paying upwards of 33% in taxes, depending on your state.
Methods for Deferring Capital Gains Taxes on Real Estate
While everyone wants to know how to avoid paying capital gains taxes on their rental property or investment property, it is important to note that you can’t legally avoid taxes altogether. However, you can employ various strategies to reduce and/or defer capital gains tax on real estate.
To defer taxes is to structure your sale in such a way that you delay paying your taxes all at once. Deferring allows you to pay taxes over time in installments or postpone paying until the timing is optimal, or even indefinitely. We can help you with these options for reducing and deferring your capital gains taxes on real estate:
121 Home Sale Exclusion
The 121 Home Sale Exclusion allows taxpayers to exclude a portion of the gains from a home sale from their taxable income, thus reducing their tax burden. This is the first place to start for homeowners wanting to know how to reduce or defer capital gains taxes on a primary residence. However, this exclusion comes with some specific restrictions:
- Primary Residence – The real estate being sold must have been owned and used as a primary residence for at least two of the five years before the sale.
- Limits on Exclusions – The exclusion is capped at $250,000 for property owners filing as single or married owners filing separately. It is capped at $500,000 for married owners filing jointly.
- Frequency – You can only use this exclusion once every two years.
1031 Like-Kind Exchange
A 1031 Exchange is a tax deferral strategy you can use when selling an investment property by reinvesting the proceeds into another similar investment property. Most people looking into how to avoid capital gains tax when selling investment property are familiar with this method of tax deferral, but it has some significant limitations.
- Investment Property – The 1031 Exchange only applies to properties owned for business or investment. If you have been using the property as a primary residence, it won’t qualify.
- Like-kind Requirement – In a 1031 exchange, you defer your taxes by essentially trading one property for another. According to the IRS, the second property must be “like-kind.” While this is a somewhat vague description, it essentially means that what you purchase must be a real property in the United States for business or investment purposes.
- Time Limitations – When you sell your real estate, the proceeds are held by an independent, third-party intermediary. You then have 45 days to designate a potential property to purchase and 180 days to close on the property. If you don’t meet either of those time requirements, the 1031 exchange will fail, and you will owe the full capital gains taxes.
A Deferred Sales Trust
A Deferred Sales Trust is a lesser-known strategy for deferring capital gains taxes on real estate. It avoids the limitations of the 1031 exchange, giving property owners and real estate investors increased flexibility in crafting their investment strategy.
What is a Deferred Sales Trust?
A Deferred Sales Trust is a specific form of what the IRS code refers to as an “installment sale.” In a Deferred Sales Trust, instead of selling the property directly, you sell to a third-party trust that sells the real estate asset and receives the proceeds. In exchange, you are given a promissory note and paid the proceeds in installments over time.
The Deferred Sales Trust makes deferring capital gains taxes on your property sale possible. You don’t have to pay any taxes until you start receiving proceeds, and then you only pay on the portion of the profit you receive in each installment. If you set up the trust to only receive the interest earned, you can postpone paying capital gains taxes on your sale indefinitely.
Benefits of Using a Deferred Sales Trust When Selling Property
Even if you plan to reinvest the proceeds of your property sale back into real estate, there are some clear benefits to using a Deferred Sales Trust over a 1031 exchange.
Flexibility
While a 1031 exchange requires you to reinvest in a business or investment property, when using a Deferred Sales Trust, you have the option to reinvest in a variety of investment vehicles inside and outside the realm of real estate. You can also choose to diversify and invest in stocks, cryptocurrency, art, bonds, or any combination of those.
Optimal Timing
A Deferred Sales trust is not limited to a 180-day time restriction like a 1031 exchange. This allows you the flexibility to hold your proceeds and reinvest in the real estate market at optimal times. You truly have the option of selling high and buying low without having to pay taxes in the meantime.
Secure Assets
When your assets are held in trust, they are protected from lawsuits and other tax claims. You can rest easy knowing that those gains you worked so long and hard for are secure and protected from unforeseen circumstances.
Protecting a Wealth Legacy
With the help of a Deferred Sales Trust trustee and their team of professionals, you can structure the trust in a way that allows you to pass your real estate assets directly to your heirs, all while reducing estate taxes and probate costs.
The last thing you want is for your children and grandchildren to be scrambling to figure out how to avoid paying huge capital gains taxes on their inherited property. Secure your legacy now for future generations.
Why Use Capital Gains Tax Solutions for Your Deferred Sales Trust
You Need the Help of Professionals
While the concept of a Deferred Sales Trust is simple, building and managing one requires a team of experts. Otherwise, you risk being in violation and paying taxes and penalties. Legally, the trust requires a truly independent third-party trust and trustee. Practically, you need multidisciplinary experts to pull it off.
When you choose to work with Capital Gains Tax Solutions, you get the services of an experienced Deferred Sales Trust trustee and a team of CPAs, tax attorneys, and financial advisors. We encourage you to bring your own financial advisors and professionals along as well.
This Isn’t Our First Rodeo
With over 14 years of Deferred Sales Trust experience and over 20 years of real estate experience, we know this business inside and out. We have experience helping clients across a variety of industries and in many different financial situations. We think the Deferred Sales Trust is a versatile and effective tax strategy, but we are dedicated to finding the best tax solution for your specific needs.
You can trust that we have the experience and expertise to do just that. We even make a point of connecting you with past clients in similar situations, giving you a chance to ask questions and evaluate if a Deferred Sales Trust is right for you.
Tried and Tested
Many of our clients are understandably wary when they first come to us to learn more about the Deferred Sales Trust. Many investors have never heard of the DST, and it almost sounds too good to be true. Rest assured, the Deferred Sales Trust has been scrutinized by the IRS with over 14 federal IRS audits and eight state audits. All of these closed with no changes.
Over the last 30 or so years, we have tested the Deferred Sales Trust in nearly every financial market. To ensure you can sleep soundly at night, we offer you lifetime audit defense at no charge.
How To Get Started
We understand that selling your property is a big financial decision, and you don’t want to rush into anything. We want you to have all the information you need and all the time you need to ask questions and conduct due diligence. That’s why we offer our consults for free with no obligation to continue. Here’s how the process works.
Schedule a Consult
This initial consult will be a private phone call between a member of our team and you and your financial advisor. We will review the property you wish to exit and evaluate your current capital gains tax liability. With the help of our team of experts, which includes trustees, CPAs, tax attorneys, and financial advisors, we will explain how to execute a Deferred Sales Trust and how it applies to your unique situation.
We will share the 22-year history of the Deferred Sales Trust, including the 2,000 successful cases and 14 IRS audits (all closed with no changes). Before we conclude, we will recommend some changes to your deal or escrow that you can implement immediately to ensure you have all the options available for real estate capital gains tax deferral. Our initial consultation is absolutely free, and you are not required to continue with us; we simply want you to end the call feeling informed and optimistic about your options.
Set up a Conditional Agreement
If you want to continue to pursue the option of a Deferred Sales Trust, the next step is to sign a conditional engagement agreement. Then, a tax attorney and one of our partners will structure a deferred sales trust to meet the requirements of your specific real estate sale so that it can be woven into your transaction.
It is very important that we get the timing right. You don’t want to begin the process of selling your property without the language for a deferred sales trust in place. The right language keeps the door open to use the DST.
Even though you sign an agreement, it is 100% conditional. You won’t pay us until you choose to move forward with the Deferred Sales Trust and your escrow closes.
Gather More Information and Make a Decision
Once you have the language in place for a Deferred Sales Trust, we want to meet with you again to really dial in your understanding of the DST. We also want to make sure we have a solid understanding of your financial goals and risk tolerance. We like to say that if you can give us five hours of your time and attention, we can get you to a place where you feel 100% comfortable with the Deferred Sales Trust, its track record, and how it will work for you.
We will work together to evaluate your challenges and opportunities. We work with various financial advisors, third-party real estate groups, banks, and tax attorneys who can help you explore your investment options. Once you have had ample time to research, ask questions, and explore options, you have until the close of escrow to make a final decision to use the Deferred Sales Trust.
Execute
We will work with closing attorneys to ensure everything is structured properly. In what is called a “simultaneous close,” you will sell your property to the trust, and the trustee will sell the property to a buyer. The buyer receives the asset, and the trust receives the proceeds at the close of the transaction.
You will receive a promissory note from us outlining the payment structure. Your capital gains taxes will be deferred until you receive payment. This allows you to spread out the taxes you owe over time. You have flexibility and control over your cash flow. You can also set up the trust so that you are only paid interest from your proceeds, which indefinitely defers the taxes on your capital gains.
Start Today
The best time to get your financial options in order is now. There is no risk and no obligation when you contact us for a consultation. It’s a no-strings-attached chance to see if a Deferred Sales Trust can help you defer your capital gains taxes, giving you increased liquidity, diversification, and financial freedom.
You came here wondering how to defer capital gains taxes on real estate – we believe the Deferred Sales Trust can do that and go beyond, transforming your wealth. Let us show you how.
