Seller's Capital Gains Tax on Sale

[Andrew B.]

We're in the process of purchasing our first rental property in San Diego (2 detached units with 3 beds & 2 bath each) and close at the end of April. We just had an inspection done and went back to the seller to see if he would be open to lowering the price or paying for repairs but the seller said no. He also said he wanted to back out because he found out that he's going to owe around 150k in capital gains tax (around 40%). Now this seems odd to me but I'm not familiar enough with the tax law. I'm also not sure if this matters but he owns the property through a trust. My question is if anyone knows of any creative ways we can use this to our advantage assuming he's correct on the tax he'll pay. Is there a way to lower his tax bill while benefitting us in the process that we could propose to him? I don't believe he's purchasing another home so he wouldn't qualify for a 1031 exchange. Any thoughts? Thanks in advance!!

[Brandon Hall]

@Mimi H. @Andrew B. @Account Closed

Trusts have a very different tax rate structure. The tax rates scale up extremely quickly.

If the sale will result in ordinary income to the buyer (a flip), any profit in excess of $12,400 will be taxed at a 39.6% federal rate. Additionally, MD will impose a tax rate (up to 5.75%) and the trust will also be subject to local tax rates ranging from 1.25% - 3.2%. 

Is the seller a MD resident? I certainly hope so, otherwise he/she is toast. MD has such a horrible tax structure for non-resident real estate sales. It's seriously mind boggling. Add 10% to the numbers mentioned above and that's what a non-resident will be looking at.

If the sale will result in long-term gains, any profit in excess of $12,400 will be taxed at a 23.8% rate. Then of course we have the MD taxes mentioned above. Better, but still not great.

While trusts certainly play a role in terms of asset protection, estate planning, and sometimes tax planning, let this be a lesson to all who read that you seriously need competent advice from both the legal AND the tax side prior to moving forward with a business structure. There could be a great reason he seller is using a trust, but my bet is that he didn't fully understand the implications.