If you’re thinking of selling real property that will result in a gain, there are a number of issues that impact the amount of taxes you will owe, and you should be aware of the tax planning steps that can be taken to minimize the gain, defer the gain, or spread it over a number of years.
Adjusted Basis
Let’s begin with the property’s adjusted basis. When computing the gain or loss from the sale of property, your gain or loss is determined from your adjusted basis in the property. This means your gain or loss would be the sales price minus the sales expenses and adjusted basis. Determining adjusted basis can sometimes be complicated, but simply stated, it begins with the acquisition value and is then increased for improvements to the property and decreased for depreciation taken on the property. The acquisition value could be your purchase price for the property, the fair market value of an inheritance or, in the case of a gift, the donor’s adjusted basis at the time of making the gift. As you can see, it is extremely important that you keep track of your basis, since it is a key factor in determining gain or loss upon the sale of the property. Failure to keep adequate documentation could result in you overpaying your income tax.
Passive Loss Carryover
If the property was a rental and the rental operated at a loss, there is a chance that the losses were not fully deductible in the year(s) of the loss because of the passive loss limitation rules. This creates a passive loss carryover that can be used to offset the gain. In addition, current year passive losses and passive loss carryovers you may have from other properties can also be used to offset any gain from selling a rental property
Installment Sale
In an installment sale, the seller acts as the lender to the buyer. When set up as an installment sale, part of the gain is reported for each year that payments are received, typically as capital-gain income. In addition, the interest that the buyer pays the seller is taxable as ordinary income to the seller. Remember, if the buyer pays off the loan early the balance of the profit from the sale is taxable at that time.
Tax Deferred Exchange
Another option if the property is held for investment or used in a trade or business is to defer the gain into the future. This is accomplished by using the rules of IRS Code Section 1031, which allows the taxpayer to acquire like-kind property and defer the gain into replacement property, which also must be used for business or be held for investment. The rules for like-kind exchanges are complicated, have strict timing issues, and require advance planning with a professional familiar with Section 1031 rules.
Qualified Opportunity Fund (QOF)
Taxpayers who have a capital gain from selling or exchanging any property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. Only the gain need be reinvested in a QOF, not the entire proceeds from the sale. This is a significant difference from a 1031 exchange where the entire proceeds must be reinvested to defer the gain.
Home Sale Exclusion
If the real estate is your home (primary residence), there are special rules. Generally, if you own and occupy the home in two out of the five years prior to the sale, you will be able to exclude a substantial portion of your gain. The tax-deferred exchange rules do not apply to personal-residence sales. The amount of the home exclusion can be as much $250,000 ($500,000 for married couples filing jointly).
South Florida Real Estate Tax Planning
As you can see, tax planning for real estate can include a number of issues, and minimizing current taxes requires careful consideration . Please call our office at 561-826-9303 for assistance in planning your real estate transactions.