How do you defer Capital Gains when selling an asset like real estate or a business?
There is a little-known way to dispose of assets that allows you to maximize your long-term financial advantage…even helping you for retirement.
Here is an example based upon clients of mine:
John and Jane are ~10 years from retirement. Like many of us they neglected to save (liquid assets) enough to get them through retirement. But they had some assets that they could sale to “top off” their savings. John and Jane had acquired several coastal lots (in an inheritance) in Central California. Property values had gone up steadily over the several years that they had owned them and they decided to enlist my help to sell them and raise some cash for retirement. If they had sold them immediately upon taking possession of them they would have had no capital gains tax. This has to do with the “basis” on which the capital gain is calculated and a little too complicated for this short of an article. Because of them “holding” them the capital gains tax was based upon the “stepped up” value at inheritance and the sale value. Result – they were looking at a long-term capital gains tax hit of ~$500,000. And guess what – the capital gains tax had to be paid the tax quarter after the sale!
Current federal long-term capital gains tax rate is ~15-20%, depending on your marginal tax rate on your ordinary income. Most states charge 5-10% above that, and the reason I will be leaving California when I retire is that California charges ~13.3% causing a total capital gains tax of close to 37%. If you took a depreciation allowance – may God be with you! We are not over yet. Capital gains are added to your AGI in the year you sell. This is going to hurt! All sorts of negative things can occur because of this.
A 1031 Exchange – Very simply, you may defer capital gains and relate federal income tax liability by “exchanging” one property for another. Rules do apply and a “sit down” consultation with your accountant is a must.
My clients chose to exchange for a commercial rental property and live on the proceeds during their retirement.
A Deferred Sales Trust – my clients could have chosen to:
Sell the lots to a buyer that agreed to pay them in installments – principal + interest. This spreads out the capital gains tax over the length of the loan. THERE IS RISK IN THIS OF COURSE. 2nd Option is transfer to a 3rd entity that can sell them for nothing? The 3rd party would promise to pay my client the proceeds of the sale in fixed installments. Capital gains tax would be paid on the installment payments within that tax year. This is where the Deferred Sales Trust comes into play. Very simply put – one person holds legal title to an asset for the benefit of another. The DST strategy has the potential to generate substantially more money over the long term than a direct, taxed sale. Because the taxes are deferred, the DST arrangement is able to leverage the entire amount of the sale proceeds to provide a larger cash flow through investment.
TALK TO YOUR ACCOUNTANT AS THERE IS A GREAT DEAL MORE INFORMATION NEEDED TO MAKE THE PRUDENT DECISION CONCERNING YOUR RETIREMENT.
Douglas J. Sedam
The Paseo Financial Group, Inc.
27413 Tourney Road #140
Valencia, CA 91355
Phone: 661.295.2400 #1
Toll Free: 866.549.3900
Securities and Investment Advisory Services offered through Financial West Group which is a member FINRA/SIPC. OSJ Office: 19510 Ventura Boulevard #211 Tarzana CA 91356 (818) 996-3375 The Paseo Financial Group, Inc. and Financial West Group are unaffiliated companies.