Before we pass along any information regarding third-party tax information, we are required by the Bureau of Real Estate to disclose that we are not offering any tax advice as we are not licensed to do so.
Here are several vehicles we have seen implemented to effect this outcome.
You probably already know that if you sell your home you may exclude up to $250,000 of your capital gain from tax. For married couples filing jointly, the exclusion is $500,000. Also, unmarried people who jointly own a home and separately meet the IRS threshold tests can each exclude up to $250,000.
The law applies to sales after May 6, 1997. To claim the whole exclusion, you must have owned and lived in your home as your principal residence an aggregate of at least two of the five years before the sale (this is called the ownership and use test). You can claim the exclusion once every two years.
This is why families who stay in the same home for decades suffer a greater tax that more mobile families avoid by moving each time they approach the $500,000 capital gain threshold.
So what happens if you’ve already exceeded the $500,000 exclusion limit on your primary residence? Here are two ways to defer or avoid the excess gain you may realize.
#2 STARKER 1031 EXCHANGE
The 1031 Exchange, or “Starker Exchange” named after the Defendant in a lawsuit with the IRS, Starker v. United States, which was overturned by the appellate court and ruled in favor of Mr. Starker. This case law was later reeled in a bit by Congress after the IRS defeat, but in the end it allows one to sell one property and invest in another “like” property and avoid paying capital gains. Of course there are many rules one must follow such as the replacement property must cost at least $1.00 more than the one you sold and you only have 45 days to identify a replacement property and 180 days to close escrow. There’s an intermediary company that must be in constructive receipt of the funds after the first property is sold as to avoid realizing the gain, but those are details that an exchange company will gladly guide you through.
But what if you don’t want to exchange into a “like” property? Then this next Deferred Sale Trust arrangement is an excellent option.
There’s also what is referred to as a Deferred Sale Trust. Essentially, the process starts when a property owner sells its property to a trust owned by a third party company. The trust sells the property or stock. Next, the trust “pays” you. The payment isn’t in cash, but with a payment contract called an “installment contract.” The contract promises to make payments to you over an agreed period of time. There are zero taxes to the trust on the sale since the trust “purchased” the property from you for what it sold it for. The payment is made with an installment contract which makes payments to you over an agreed period of time.
Knowing how to use these opportunities to your benefit can make a difference in your estate planning—especially on the Peninsula where our home values increase so rapidly and the $500,000 gain relief threshold can be reached in a matter of a few years.
If you have questions for the author, Drew Morgan, you may reach him at 650-590-4525 or email email@example.com.
Drew & Christine Morgan are REALTORS/NOTARY PUBLIC in Belmont, CA. with more than 25 years experience in helping sellers and buyers in their community. They may be reached at (650) 508.1441 or emailed at firstname.lastname@example.org.
You can find them on Facebook at https://www.facebook.com/Morganhomes and also find them on Twitter @ https://twitter.com/morganhomes
The information contained in this article is educational and intended for informational purposes only. It does not constitute real estate, tax or legal advice, nor does it substitute for advice specific to your situation. Always consult an appropriate professional familiar with your scenario.