As we approach the later stages of life, finding ways to avoid giving up a large chunk of whatever wealth we have managed to accumulate to taxes becomes a common preoccupation. It is also when most people are looking to cut back on their daily worries. In terms of properties, this translates to what a client summed up best when he counted his real estate wealth in terms of the number of toilets that he owned.
Two of the more significant government-driven tax incentives in Real Estate include the Capital Gains Exclusion on primary residences and the Tax-Deferred Exchange that allows income properties to be traded into other income properties while postponing or even ultimately avoiding Capital Gains taxes as long as they meet required guidelines. Tools for achieving the ideal balance between wealth and workload can also include hiring a good Property Manager, or exchanging from multiple higher-maintenance residential properties into a few larger low-maintenance holdings such as NNN leased commercial properties, which tend to have much lower turnover and their maintenance built into the lease terms.
But what do you do when you want to get off the real estate merry-go-round entirely? Some property owners simply choose to bite the bullet and pay the 1/3 or so of their accumulated proceeds to taxes, while others use various strategies such as exchanging into an investment property and then converting its use into a primary residence after a few years to be able to get up to $500,000 of their capital gains excluded. Others choose to do an installment sale and carry a note to give them a source of fixed income while deferring the Capital Gains taxes until the Principal is paid off.
One of the most valuable tools in terms of protecting a family’s investments and passing them on from generation to generation is setting up a Revocable Trust, which should be handled through an attorney who can structure it correctly for each family’s unique needs. In most circumstances the property gets a stepped basis on the death of the parent so that prior capital gains are eliminated.
There are multiple other ways to eliminate capital gain, such as through the use of a Charitable Trust arrangement, which is powerful but very complex, and too complicated to go into here. Another common issue for cases where one sibling wants to buy out the others is the increase in property taxes on the purchased interest, which can be greater than most capital gains liability. There is a very narrow way to prevent the reassessment, which involves the use of a short-term hard money loan to the trust or estate to buy out an interest.
The bottom line comes down to planning ahead to develop the best plan for minimizing your tax consequences. The strategies I have outlined here are just a few general tools, and there are exceptions to every rule. And of course, any strategy should be handled with the help a qualified professional, and I can recommend several locally, depending on your particular situation.
