Monday, April 02, 2007

Minimizing Sometimes Possible Even After the Sale

Recently, I was presented with a fairly unusual scenario. A man in New York City was paid 500K as a buy out on a rent controlled lease. He'd been there 20 years and was one of only 5 tenants left in a building on prime land where the owners wanted to tear down the building and build a skyscraper.

The buyout was actually considered as a long term capital gain, even though the tenant never owned the real estate. Money had already changed hands, so a taxable event had occurred. It was too late to defer capital gains tax, but not too late to minimize the tax burden due to the best extent possible and still have him meet his goals.

Here was the plan I presented to him. His goal is to use the money to buy a primary residence, and the means is to do a Charitable Installment Bargain Sale using cash.

"If you pay your taxes, you'll owe a little over 25% of 500K or about 125K. So you either start with 375K left over and use that as a down payment on something or strategize for something better. If you put it into real estate, the 375K doesn't earn interest, the equity increases just as it would whether or not the property was financed to a greater extent.

The example attached shows keeping 100K and putting 400K through the public charity in exchange for 507K back over 15 years plus an upfront tax deduction of 216K .

By using the tax deduction, you will reduce your capital gain due by 43% (the 216K deduction) so you will owe about 71K vs 125K. The 100K kept out more than covers your tax bill and leaves you with some to spend. You could use the 29K for a down payment.

The illustration is for 15 years, but can be shorter or longer. Here, you get almost 3K per month for 15 years. This should be enough to pay any mortgage off in the 15 year period if you want to buy a place. This also gives you a mortgage interest deduction to further reduce your taxes and 100K more than you put in back as payments. Most of the payments received will be income tax free, as it is a return of cost basis. Only the interest component is taxable. The funds are also protected from creditors during payout.

You save an immediate 54K in taxes and get basically a rent free place to live that's paid off in 15 years, as well as lower income tax bills and the appreciation which will also be tax free up to 250K.

Let me know if this makes sense to you. I think it really puts you way ahead of paying a lump sum and gives you a steady income stream (mostly tax free) you can depend on and a roof over your head that is basically paid for in total."

The capital gains could have been spread out over the 15 years if a strategy had been put in place prior to sale, but in this case, even after the fact a plan makes a huge difference.

Paula Straub

Fill out a Qualification Questionnaire to determine how you can save capital gains tax.

Bad Advice Can Really Break You

As I've said before, the calls I dislike the most are from those individuals that have already sold their asset and are desperately trying to figure out a way to reduce their capital gains tax.

My business is not really driven by any particular event, such as tax filing time, but it is from February to April that a lot of people actually realize what their tax consequences are and panic.

In most cases, it is too late to do much but pay the piper. The tragedy is, the money is not always there to cover the bill.

A fellow in Florida sold a rental property last year at a nice profit. He had paid about 70K four years ago and sold for 800K. He owned it with another family member, and both had put quite a bit of money into fixing it up, and had taken out a number of high interest loans to finance it.

His tax preparer had told them they would only owe 5% in capital gains tax, so they each set aside 20K for taxes. After paying off the loans (including a large balloon payment), they each had about 120K left over.

Now with tax deadlines approaching, this same tax preparer has called them back and told them he was wrong in the estimates. What he didn't realize at the time he originally advised them, is that only a small portion was going to be taxed at 5% , and the majority will be taxed at 15%. He also neglected to mention the recaptured depreciation that will also be due, taxed at 25%.

They each will owe more than 40K in additional taxes come April 17. Neither party has this amount left over from their proceeds. They thought they were free to spend the amount left over after they set aside the original 20K. Luckily, they live in a state where there is no state capital gain tax or their problem would be even greater.

They will have to take out loans to pay the tax bill. All this could have been avoided had the right advice been given from the get go. The time to do research and seek specialized counsel is before the sale happens.

Paula Straub

Fill out a Qualification Questionnaire to find out what options you have to save capital gains tax.