Can Seller Financing Reduce Capital Gains?

[Hans Thurau]

I have a beach duplex in Southern California valued at around $1.8M; I originally purchased it for $350K. If I do a standard sale, my long term capital gain minus my $250K primary residence exemption will be high considering my gains are over $1M. One strategy I considered is to offer seller financing (me being the seller). I do not have experience with seller financed transactions... would the down payment be subject to capital gains tax (and/or the monthly payments)? Additionally, are the monthly payments I receive taxed at the same "capital gains rate" considering there would be interest on top of principle included in these payments? Any advice is greatly appreciated.

[Dave Foster]

@Hans Thurau, An installment sale can postpone a recognition of gain and the associated tax bill but not eliminate it. Your acct. would structure the reporting of the installment sale.  The income will be classified into interest, return of basis, and gain.  Every dollar to you will have these same components.

Another option for you that would require some patience would be to move out of the house and rent it for a year or two.  Then when you sell you would do a 1013 exchange since it is now investment property and you would take taxable boot of $250K.  Normally the boot would be taxable but since you'll still qualify for the 2 out of 5 exemption it is tax free.  And the remainder goes into your 1031 exchange all tax deferred.  Your only tax bill in this scenario would be the recapture of depreciation during the time it was a rental.