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Strategies for Avoiding Capital Gains Tax

   

The inevitable certainty of having to pay capital gains taxes will darken the mood of any investor or rental property owner.  Dreams about a hefty paycheck and a nice return on all of the blood sweat and tears that have been poured into a rental property can become just that—dreams.

As a local Realtor serving Wilmington, NC and the surrounding areas, I have had a lot of clients and friends ask me if there is a way to save money and keep more of those hard-earned funds in the good old bank account.  Considering all of the costs and hassles that owning a rental property can bring, I can certainly understand the motivation to sell an investment property and avoid the headaches.

It's about what you keep.png

To provide a bit of backstory, having to pay capital gains taxes is a good problem to have.  This is because capital gains taxes only pertain to people who have had a rental property for at least a year and have made a profit on it.  Tax rates vary from zero to 20 percent, depending on the taxpayer’s adjusted gross income.

Conventional wisdom states that a 1031 exchange is one of the best strategies for avoiding the payment of a capital gains tax.  A 1031 exchange is when an investor swaps out one rental property for another of ‘like-kind’ or similar value.  Since the funds are held in a trust until a replacement property is identified and purchased, the investor is allowed to defer the payment of capital gains taxes.

In light of the market appreciation we have seen over the past few years, an exchange might not be the best idea for reducing capital gains taxes anymore.  Instead it may be worthwhile to consider the following strategies for avoiding capital gains tax:

  • Deferred Sales Trust – This is when a rental property owner creates a trust prior to the sale of the property.  The trust then sells the property to a buyer, using a Realtor as an intermediary.  The net proceeds from the sale are held in the trust, which uses the funds to invest in stocks or mutual funds at the property owner’s direction.  The property owner is also allowed to carry a loan note back from the trust.

  • Charitable Remainder Trust – Setting up this type of trust can provide income for life for the property owner or anyone they specify.  As the name implies, any remaining assets left over after the remaining beneficiary dies would pass along to the charity that was designated when the trust was created.

 

  • Installment Sale – A property owner who chooses to offer a lease/purchase option can defer some capital gains by doing an interest-only note on the property.

As the saying goes, “it’s not about what you make; it’s about what you keep.”  With this in mind, it’s easy to see how finding a way to reduce capital gains tax or avoid it altogether could quickly become an investor’s sole purpose in life.  Of course it is always a good idea to consult a tax specialist prior to making a decision. 

If you have questions or would like to chat about liquidating your investment property, please contact me at 858-692-5120.

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