How to sell without paying exorbitant taxes?

Question

Joel Owens · Answer

If you want to move all the proceeds with a sale then look at doing a 1031 exchange. If you want to keep the property look at a refinance out up to 75% of the current value and put a loan on it.

You could possibly look at owner financing a note with some down on your property and take payments in an installment agreement to minimize capital gains each year.

Additionally you could invest in a DST or a TIC model as a passive investor.

When you sell you have to look at not only long term capital gains tax but any depreciation recapture from write down you have taken over the years. Also some states have an income tax if you do not 1031 exchange on a regular sale. There used to a be a 3.8% medicare tax but might have gone away with the new tax law.

You could sell and 1031 exchange into a passive commercial NNN asset where you do nothing but collect the check. Investors get tired of working for yield so when they make big gains selling off properties they want to now be passive and have the income stream.

You need to figure out your expected proceeds amount from a sale plus what you tax liability is if you do not complete a 1031 exchange but want to do  regular sale. In some cases not doing a 1031 exchange could take up to half of your expected profit. What some do is 1031 exchange and then pull out some of the equity of the new property after closing with a refi.

Good luck.

No legal advice given

Lesley Pinckney · Answer

Thank you guys, this is really helpful.  Here is the info you requested:

• HHI  - >$400,000/year split 50/50 between a W2 salary and a owner operated business with 1099s  (not including the property revenue), ~600K in savings, current homeowners in Chicago, a little cash poor at this moment but it's temporary
• Current Brooklyn Rental Property - ~$600,000 left on the mortgage, appraised last year for $1.2MM, current comps are between 1MM-1.3MM.   Currently property has a tax abatement until 2023, looking at taxes going up 20% YOY from  >$1,000/yr to ~$12,000/yr (per our building's accountant).  Currently renting @ $4125, HOA's  are $1,200 so I'm making about $600/year when all is said and done.  According to my broker (who also agrees it's time to sell) I would see a minimum of ~350,000K in profit.

I work full-time with a fair amount of work travel, and I have a young daughter so I'm looking for something that is fairly low maintenance.  I would love to stay a passive investor and morph into an active investor the more I learn (on bigger podcasts).

Thanks!

Dave Foster · Answer

@Lesley Pinckney, Your broker is spot on.  You're not making anything and the tax abatement sunset is creeping up on you.  I'd run not walk.

I think your plan to stay passive at this moment also sound.  It's late in the market and a lot of smart money is staying on the sideline waiting for a correction.  You don't totally have that option with the 1031.  But you can get into something will do vastly better than that after expenses and because it's 1031 compliant you can sell after the market correction and start to move into fixed assets.  Your daughter will be a little older. You'll have more cash on the outside to supplement.  And you can spend the time while making good mailbox money to educate yourself on where you'd really like to invest as an active investor.

Dave Foster · Answer

@Lesley Pinckney, There's far more "accidental landlords" than you could ever imagine.   The first big decision you face is whether you want to leave the game or stay in and be an active or passive investor.  Leaving the game involves paying taxes but frees up your capital to position else where.  Staying in allows you to continue to invest the tax dollars to your benefit.

The two aren't mutually exclusive but generally reflect a mind set about what you perceive your energy level is, your current life style and job commitment and whether real estate is a muse calling your name or a vehicle that provides cash so you can pursue your other passions.

So before I even thought of how I'd answer the"why" question first.  The answer to that question will dictate the course of your education as an "accidental landlord turned "deliberate investor" and possible sectors within real estate to investigate.

Joel Owens · Answer

Lesley,

What is your annual income from job or business? Total liquidity and net worth? Are you an accredited investor? Worth 1 million or more excluding primary residence and or income exceeding 200k plus a year for the last 2 years?

How much proceeds do you anticipate from the sale of this property?

200k,500k,1 million?

The direction you might go depends a lot on your particular situation as certain types of properties are available to exchange into at certain price point levels.

Lesley Pinckney · Answer

I’d love to become an investor and am trying to learn but concerned this is a big first step for a newbie.  Any additional info would be greatly appreciated!

Dave Foster · Answer

@Lesley Pinckney, good alternatives given by @Joel Owens.  Your opening line says "investor by default".  That indicates perhaps that your desire is not to grow as a real estate investor.  In that case the 1031 exchange can still be used to defer the substantial tax but place you into passive products like the DST and TIC that will require no attention but generate income on the equity and the deferred tax.

First order of business is to calculate the potential gain and tax from a sale now.  2nd is to do a opportunity cost of what your return could be on only the equity on the property after tax if placed into a non-1031 compliant vehicle versus investing equity and tax into a 1031 friendly vehicle.

The tax code portion of it is relatively simple and your accountant probably has your gain proforma at their finger tips.  And sheltering the tax in a 1031 exchange is not difficult.  The more difficult exercise is if you want to save the tax then where do you go.

How to sell without paying exorbitant taxes?

Most Popular Reply