Capital gains on sale of a rental question
March 17, 2016 7:44 PM Subscribe
My mother-in-law is selling, or thinking of selling, a house she's owned forever. It's been paid off for decades. She hasn't lived in it for 5 years (has had it rented out by a property manager) and is looking at a huge capital gains tax if she sells. What alternatives does she have to reduce the tax burden?
Okay, YANMCPA. I won't take anything written here as gospel and am using it mostly for reference and to get some perspective on this. My mother-in-law is in her 90's. She doesn't want to manage the property as a rental any longer, and her daughter living near her doesn't either. It's just a time suck for them and the property manager they've used for the past 5 years did a relatively poor job of it.
So, they want to sell or are inclined to do so. It's not a done deal yet, just a topic of discussion.
Their financial adviser is telling them their capital gains tax on a sale (in California) is in the neighborhood of $85k, which seems huge to me. I'm thinking there must be some creative alternatives. Her estate is mostly in trust now and she's preparing to have less and less responsibilities over the next decade. She lives fairly close to the property and is losing her attachment to it as a family home. So, what to do?
So, given my explanation is second or third hand, and probably doesn't cover all the salient details, how else could we think about this to legally reduce the tax burden? There is no real pressure to sell right now, other than the RE agent advising them to get it done.
For my part, this post is a way of me being able to say to them "have you thought of this?" so they could have other alternatives to research, if there are any. Thanks.
Okay, YANMCPA. I won't take anything written here as gospel and am using it mostly for reference and to get some perspective on this. My mother-in-law is in her 90's. She doesn't want to manage the property as a rental any longer, and her daughter living near her doesn't either. It's just a time suck for them and the property manager they've used for the past 5 years did a relatively poor job of it.
So, they want to sell or are inclined to do so. It's not a done deal yet, just a topic of discussion.
Their financial adviser is telling them their capital gains tax on a sale (in California) is in the neighborhood of $85k, which seems huge to me. I'm thinking there must be some creative alternatives. Her estate is mostly in trust now and she's preparing to have less and less responsibilities over the next decade. She lives fairly close to the property and is losing her attachment to it as a family home. So, what to do?
So, given my explanation is second or third hand, and probably doesn't cover all the salient details, how else could we think about this to legally reduce the tax burden? There is no real pressure to sell right now, other than the RE agent advising them to get it done.
For my part, this post is a way of me being able to say to them "have you thought of this?" so they could have other alternatives to research, if there are any. Thanks.
I think a single person that has occupied a house for 2 of the 5 previous years will not pay gains tax on the first $250k.
She can owner occupy again for 2 years (or maybe her daughter can), but if the house is worth a lot more than $250k the owner occupant exception only covers the first $250k.
Check with your tax person. She will probably have to pay gains on the rental years no matter what.
posted by littlewater at 8:23 PM on March 17, 2016 [2 favorites]
She can owner occupy again for 2 years (or maybe her daughter can), but if the house is worth a lot more than $250k the owner occupant exception only covers the first $250k.
Check with your tax person. She will probably have to pay gains on the rental years no matter what.
posted by littlewater at 8:23 PM on March 17, 2016 [2 favorites]
90k tax implies at least a long term gain of 450k, based on my poor understanding of tax rates, not a shabby amount of money.
Maybe spend a few dollars on a local estate planner or tax attorney?
posted by TheAdamist at 8:39 PM on March 17, 2016 [1 favorite]
Maybe spend a few dollars on a local estate planner or tax attorney?
posted by TheAdamist at 8:39 PM on March 17, 2016 [1 favorite]
1031 exchanges are very flexible. She could even exchange it for a commercial property. You have a certain time period to find a new property (or properties!) after you sell the original one. A 1031 exchange is not limited by geography, either. You can buy a property anywhere in the US.
It's definitely time to line up a tax attorney.
posted by Ostara at 9:03 PM on March 17, 2016 [1 favorite]
It's definitely time to line up a tax attorney.
posted by Ostara at 9:03 PM on March 17, 2016 [1 favorite]
It may depend on whether she is more interested in leaving a legacy for her heirs or in covering her own needs. Keep in mind that when property is inherited, the cost basis for capital gains purposes is 'stepped up' to the value at death, meaning the heirs would only pay taxes on the gain between the date of death and sale of the property. Given the amounts and ages in question, it might be worth getting a better property manager for a few more years, if the income from the property is sufficient contribution to her expenses and the cash from a sale isn't immediately needed.
But if they really want out, the good news is that as an income property with no personal use, she should be eligible for a 1031 exchange (again, assuming total liquidation into cash isn't needed). This would defer capital gains indefinitely and give her the opportunity to get into a more passive real estate investment. Usually you could still take advantage of basis step up on the new property, and the tax liability would be permanently avoided upon her death. An estate planner should really be involved with the overall decision making - a competent one will also definitely be familiar with 1031 exchanges. If her current financial adviser wasn't aware of this option, that would worry me a little - it's not obscure information. I don't see any reason why paying capital gains tax would be on the table at all here, considering the info we have.
posted by pekala at 9:13 PM on March 17, 2016 [8 favorites]
But if they really want out, the good news is that as an income property with no personal use, she should be eligible for a 1031 exchange (again, assuming total liquidation into cash isn't needed). This would defer capital gains indefinitely and give her the opportunity to get into a more passive real estate investment. Usually you could still take advantage of basis step up on the new property, and the tax liability would be permanently avoided upon her death. An estate planner should really be involved with the overall decision making - a competent one will also definitely be familiar with 1031 exchanges. If her current financial adviser wasn't aware of this option, that would worry me a little - it's not obscure information. I don't see any reason why paying capital gains tax would be on the table at all here, considering the info we have.
posted by pekala at 9:13 PM on March 17, 2016 [8 favorites]
A charitable gift annuity would help reduce/defer the capital gains tax amount.
posted by entropyiswinning at 10:48 PM on March 17, 2016
posted by entropyiswinning at 10:48 PM on March 17, 2016
Spend the dough and get a good CPA. Well worth the money. Will explain your options and give you advice for valuation as well as how best to preserve value.
Our CPA helped us out of a jam and got us a great write-off on a piece of property we owned and when we 'sold' it, we paid no taxes on it. If this is rolled into estate planning, you want a CPA even more.
Financial Advisors are good with investment strategies, but a CPA will know all the ins and outs of this sort of thing.
posted by Ruthless Bunny at 5:26 AM on March 18, 2016 [2 favorites]
Our CPA helped us out of a jam and got us a great write-off on a piece of property we owned and when we 'sold' it, we paid no taxes on it. If this is rolled into estate planning, you want a CPA even more.
Financial Advisors are good with investment strategies, but a CPA will know all the ins and outs of this sort of thing.
posted by Ruthless Bunny at 5:26 AM on March 18, 2016 [2 favorites]
A 1031 exchange is the typical way to defer capital gains tax on property, but for someone in their 90s, there probably won't be too many years of deferral anyway. At death, the cost basis is stepped up so the capital gains disappear. Besides, the reason for selling is to get away from the hassle of property ownership and a 1031 exchange just transfers one headache for another. And fees and commissions for an exchange are not trivial.
Unless cash is needed immediately, the simplest solution is to just find a better property manager, one that will handle all the headaches, despite a higher fee. If you need cash now, you can take out a loan on the property which will be paid back from proceeds of the sale from the estate of the deceased. This eliminates all capital gains taxes.
posted by JackFlash at 12:34 PM on March 19, 2016
Unless cash is needed immediately, the simplest solution is to just find a better property manager, one that will handle all the headaches, despite a higher fee. If you need cash now, you can take out a loan on the property which will be paid back from proceeds of the sale from the estate of the deceased. This eliminates all capital gains taxes.
posted by JackFlash at 12:34 PM on March 19, 2016
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posted by slidell at 7:59 PM on March 17, 2016 [1 favorite]