HOW TO NOT PAY ANY TAXES ON CAPITAL GAINS
Based on a new tax law, you can avoid capital gains if you follow these strategies. Example one: If you have a rental property and you sell it for $3 million and your cost is $1.5 million, your profit will be $1.5 million. Your taxes on the profit will be between $500,000 and $700,000. You and your spouse or significant other can avoid paying those taxes by trading for three single-family rental properties—Property A, Property B, and Property C. You then rent them out. If you try to rent Property A and you can’t, live in it for two years and sell it, the $500,000 profit based on the new tax law, is excluded. Then you move to Property B and live in it two years. When you sell it, you do not pay any taxes on the $500,000. Then, live in Property C for two years. Sell it and you don’t have to pay any taxes on the $500,000 either.
Example two: Sell your rental property for $3 million to a limited partnership whose partners are not blood relatives. Take $1 down and a note for $2,999,999. The tax on that dollar is 33 percent. The limited partnership sells the property for fair market value to an unrelated third party for $3 million. The tax is zero because the basis is $3 million. The partnership can pay you installment principal payments on your note, and you’d be paying percent taxes on that profit. However, you’d bespreading income over a number of years. You can gift portions of that note to individuals, thereby spreading the income over entities. Alternatively, you can leave it in your estate; it is possible that you will not have to pay taxes on it at all.
New IRS tax laws allow you to take what’s called catch-up depreciation deductions that you have not previously taken. This procedure allows you to take the entire deduction in the current year. The election must be made in the first half of the tax year in which the catch-up deduction will be taken. This method benefits anyone who is allowed to take a depreciation deduction. For example, if you didn’t take deductions in the prior years for one reason or another, and you decide, based on your in-come, to offset an anticipated increase in income with catch-up depreciation, you may do so. This is called grouping income and deductions.
LANDLORD/LEASEE TAX STRATEGIES
Instead of paying for the lease improvements, have your landlord pay for any lease improvements. The landlord can write these lease improvements off over a 39-year period. If you made the lease improvements and paid the cost of the improvements, you would have to write them off over 39 years. To increase the deduction, pay for the cost of these improvements by increasing the rent. Therefore, you’re accelerating the rent expense instead of deducting the lease improvements over 39 years. The landlord is reimbursed for the improvements in the form of rent payments and enjoys the annual deduction for the appreciation. Instead of spreading the cost of these improvements over 39 years, you’re actually spreading them over the life of the lease, which could be less than 39 years.
HOW TO MAKE A TAX DEDUCTIBLE GIFT
If you give your children a gift every year for tax purposes, it is not deductible. However, you can instead treat your child’s home as your second home and make the mortgage payment on it. This only applies if you don’t own a second home yourself. The same strategy can be used to make gifts to your parents or certain other family members. Make the home mortgage payments for them and deduct the mortgage interest portion of the payment on your tax return. This will free up cash for your children or parents that they would otherwise have used for mortgage payments. In this way, you’re indirectly making a tax-deductible gift to your children. Interest payments must be legally enforceable debt; therefore, you must co-sign the loan. This strategy is called spreading the income and deductions to entities. If your family members are in a higher income bracket, it won’t work. It doesn’t have to be made on the same house each year. For example, if you have five family members and you co-sign on all five loans, you can make loan payments in any one year to any one of the five. Children are not the only ones who qualify. You can also have this arrangement for your parents, grandparents, grandchildren, or your brother or sister.
GIVE THE BOOT TO BOOT
Based on an IRS revenue ruling, it is now possible to offset boot with other transactional expenses. For example, if an investor traded down from a $500,000 property to a $400,000 property, a $100,000 boot would be recognized. When the transaction is reported, he automatically reduced the amount of the $100,000 boot by all transitional cost, such as commissions and other closing costs incurred.
ABOUT THE AUTHOR: Eugene E. Vollucci, is considered to be one of the foremost authorities on real estate taxation and real estate investing and has authored books in these fields published by John Wiley & Sons of New York. He is the Director of the Center for Real Estate Studies, a real estate research organization. To learn more about the Center for Real Estate Studies, please visit our web site at http://www.calstatecompanies.com