"Thinking is one thing no one has ever been able to tax" - Charles Kettering
As we wrap up our newsletter series on taxes, we saved the best strategies for last. Today, we are going to do an overview of the legendary process of deferring taxes that just about no one thinks of, and what most agents despise. Keep reading and you will understand even more how MinnGo puts clients first!
The average real estate agent treats the sale of your property merely as a transaction. However, in today’s market and growing economy, it is important to understand the complexities and nuances that various transactions can raise. At MinnGo, our unique expertise allows us to present you with comprehensive and strategic approaches to the sale of your property. Ultimately, our goal is to help you achieve the most value from your transaction. Below are some unique methods that are often over-looked by your run-of-the-mill agents, but which have very important tax consequences.
1) Installment Sales – Installment Sales are almost identical to a traditional sale, except it spreads the payment for the property across various dates. Instead of getting the full sale price (minus any selling costs and debts) at the close of the sale, installments are paid to the seller over an agreed upon time. The installments can be spread out across multiple months, or even years. In each installment payment, part goes toward the seller’s adjusted basis, part to interest, and part toward the seller’s gain/proceeds. By spreading the sale across more than one tax year, the seller may be able to reduce his or her overall tax burden. When doing an installment sale, MinnGo will work directly with you and your accountant to structure the most tax advantageous structure that we can.
2) Combined Primary and Investment Property – Combined primary and investment properties most commonly include 2-4 unit owner-occupied and in-law properties. In these situations, to maximize the seller’s profits and tax benefits, the seller is able to divide his or her property into two separate categories: primary and rental (think of a duplex, where one unit is used by the owner as a primary residence and the other unit is rented out). By doing this, 50% of the property can be treated by the IRS as a primary residence and 50% can be treated as an investment property (the actual percentages often are based on square feet). As a result, when an owner sells his or her property, the seller may be able to qualify for the capital gains exclusion on the primary residence and 1031 exchange on the investment side.
3) Converting an Owner-Occupied Property Into a Rental – Converting an owner-occupied property into a rental unit is probably one of the least talked about scenarios, but should always be presented as an option to a seller! In this situation, the seller actually moves out of the property and turns the former primary residence into a rental property. After the property becomes held for productive use in a trade or business, or for investment purposes (you would need to speak with an accountant for tax advice on how long that may be), the seller can qualify for both Section 121 and Section 1031. The end result is that the seller can get the capital gains exclusion and the benefits of a 1031 - in theory - deferring taxes entirely.
For example, I recently learned about a situation where a seller already purchased their retirement home and was selling their primary residence for far above their cost basis (purchased close to 30-years ago). Had they consulted with MinnGo prior to the sale, the conversation would have almost immediately started with taxes, and an explanation about the benefits of converting their property into a rental. Based on my analysis, by not leveraging this approach, the seller will likely lose close to $60K a year in rental income over the next year or two and pay a legally avoidable $300,000+ tax bill from the IRS this year. Had this option been presented to them, they could have had close to $400,000+ in their own account.
The above sales are more complex than traditional sales, and speaking with an informed accountant with real estate knowledge is a must. At MinnGo, we can help you with all of your transactions, and explore every option to make sure that we are making the best decision for you as a seller.
If you ever have any questions at all, please do not hesitate to reach out. At MinnGo, we realize that real estate is not something our clients think about everyday. Lucky for you, that is what we live and breath.
Until next time.