Strategies for paying off debt

[Mike Callahan]

Long story short, I’m in a position where I want to sell a few houses to pay off the debt on my portfolio of real estate. I’ve concluded that my only real option here is to bite the bullet and pay capital gains. Does anyone have any creative ideas here? The gains will be large since the basis on these properties is low. Thanks

[Ashish Acharya]

@Mike Callahan , 

If you really need to sell and use the proceeds and still defer/partially avoid taxes, there is a way. 

In 1031 exchange you cannot receive any cash, which is taxable. That means that you dont have the cash to pay off the debt. But you can invest just the capital gains in the Opportunity Zones and use the basis without incurring taxes when you sell. This is a product of the new tax reform.

This is better than 1031 exchange as you can invest just a part of your gain ( or all gain). You dont have to reinvest your basis for the benefits vs the 1031 where you have to reinvest entire gain plus basis. You can keep on adding more and more to the fund. The time limit to invest is much better than 1031 (in some cased year and a half) and so on.

If you need more detail here it is:

Benefits:

A) Temporary deferral(possible reduction)of inclusion in gross income for capital gains reinvested in a Qualified Opportunity Fund (QO Fund)

■ Held for 5 years - 10% of capital gain is avoided

■ Held for 7 years - 15% of capital gain is avoided

B) Permanent exclusion of certain capital gains from the sale or exchange of an investment in the QO Fund.

Example:

A sells a property and realizes a gain of $1 million on Dec. 1, 2021. On Dec. 31, 2021 (i.e., a date within the 180-day period beginning on Dec. 1, 2021), A invests all of the $1 million gain in a QO Fund.

If A holds (Not sold) the investment in the QO Fund until Dec. 31, 2026, as the deferral period is over, A has to include the deferred gain in A’s gross income in 2026. How much of the reinvested $1M would he include? Answer: 900,000

● Reinvestment amount = $1M

● Basis increase/Capital gain avoided = 100,000 (10% of Reinvestment as held for 5 years.)

● Gain included = (Reinvested amount - basis increase) = 1M - 100,000= $900,000.

If A also sells the investment in QO Fund in Dec 1 2031, 10 years later, he does not recognize any capital gain on the sale of his investment in QO fund.

If A sells the investment before 10 years, basis in the investment is based on the time it is sold:

Basis starts with Zero and increases in this order

■ Held for 5 years - 10% of gain reinvested

■ Held for 7 years - 15% of gain reinvested

Basis at 5 years = 100,000

Basis at 7 years = 150,000

Thus gain/loss is determined based on the FMV of the investment less the basis at the date of sale. If the date of sale was more than 10 later the initial investment, no capital gain is recognized.