Helping a seller reduce their tax consequences

[Ronald Perich]

I really want to provide my seller with some options to reduce the taxes they'll pay if they sell me their property. By helping them solve their problems, perhaps I am their first choice for the sale. Here's a quick synopsis of their situation.

They've owned these units for roughly 20 years. Assume today's sale is at $300K. Originally purchased for $250K. (Yep, there is little appreciation in this area).

Improved Property basis is probably around $200K (for depreciation purposes). The biggest hit in on the recapture of depreciation (which I believe is at 25% tax rate). They have to reduce their basis by the $145,000 of depreciation they've taken over those years. So their real basis in this property stands at $105,000. Their resulting gain in the property is $195,000.

In terms of taxes, I figure their recapture taxes will be $36,250 (25% of $145) while the remaining capital gain is taxed at 20% for a bill of $10,000. 

Add to that a decent salary for the owner.

How can I help them reduce the taxes? Or maybe delay when they pay those taxes?

A master lease option (something @Brandon Turner has talked about) is not a sale until the option is exercised, right? Maybe we do that and delay the actual sale until next year (when their personal income is less)

Amanda Han talked about seller financing as another option. But I think the recapture has to be paid at the time of the sale even when using seller financing.

Perhaps they put it into an LLC and I slowly acquire ownership of the LLC. Not even sure how the taxes are figured on that one.

So I am looking for some options. I realize none of what you will offer is specific tax or legal advice and I should seek the recommendations of a qualified tax or legal specialist. Thanks for the help!

[Dave Foster]

@Ronald Perich, There's some creative options being offered above.  I did not see the possibility listed of doing a 1031 exchange.  If your client were to go that route they could completely defer all tax indefinitely by selling their property through you and then subsequently buying new investment property.  There's some potentially huge advantages to this strategy.

first the advantage to you - A sell and a buy = two commissions.  If you're able to help them save taxes and you can get an extra commission by finding the perfect replacement property that's a huge win for everyone

The advantages to them

-They could potentially use the proceeds as down payment on a larger property or properties and effectively "buy" more depreciable basis thus helping them in future years.

-They could go from this property into a better geographical area or type of investment real estate.

-They can go from active managed to passive and save effort.

-They can make one of their purchases a property that later they convert into their primary residence and then use the rules of sec 121 to eliminate a great deal of that tax completely.  

@Brian Gibbons gives you a couple great recommendation in @Brandon Hall and

@Steven Hamilton II but I gotta disagree a little with his statement that you cannot eliminate tax ever.  In most cases true but there's two easy ways using 1031 exchanges - First convert to primary residence using the strategy above and take a big prorated chunk of the gain tax free.  You can do this every two years. Second hang on to a good cash flow property that pays for retirement and then die.  Your heirs get a step up in basis and the tax built up over the years is eliminated.