Selling Real Estate Without Paying Taxes

Selling Real Estate Without Paying Taxes

The Selling Real Estate Without Paying Taxes tax-deferral and elimination methods, discuss the pros and cons of each, and offer examples of how each method works in everyday practice. When the average person thinks of taxes, he or she usually thinks of income taxes. However, the tax system in the United States is not based on taxing income; instead, our tax system is based on taxing increases in wealth. The subtle difference in this terminology is very important, because taxing all forms of wealth increases allows the IRS to tax things other than just the earnings we take home. So in addition to income taxes, we also have taxes on gifts, interest income, debt forgiveness, capital gains, and even on death (estate taxes). All of these represent increases in wealth according to the IRS and, as such, are taxed in one manner or another.

Both income taxes and gift taxes are scaled to essentially provide that the more you make or give, the higher the percentage of taxes you pay. Likewise, estate taxes as a percentage are higher in larger estates. Taxing debt forgiveness is an odd concept but necessary in the eye of the IRS. If debt forgiveness were not taxed, companies could circumvent income taxes by simply paying wages to their employees with “loans” each month and then forgiving the debts at the end of the year. That’s a simple example of tax-planning creativity, but it makes the point that the IRS needs to focus on increases in wealth instead of merely income.

The focus of this book will be on capital gains taxes. Capital gains are actually given preferential tax treatment by the basing of the applicable tax on a flat rate. At the time of this writing, the longterm federal capital gains tax rate is 20 percent. Okay, it’s not quite that simple.

Two major revisions of the rules on capital gains taxes have been made in the last six years, and the current rates and holding periods in effect As you can see, exceptions and lower capital gains rates exist for situations where the taxpayer is in the lowest tax bracket. Also, there is certain legislative blurring of the rate lines creating the old-old capital gains rate, an old capital gains rate, and a new capital gains rate for investments
made after 2001 and held for over five years.

In a few years there will probably be a new-new capital gains rate as well, but for our purposes here, we won’t spend time on trying to analyze or predict possible
upcoming changes. The significant fact is that for the regular person in an ordinary real estate capital gain situation, the federal capital gains tax rate right now is generally 20 percent. State taxes are another matter. Each state can make its own rules for taxing capital gains.

Some states impose no state capital gains taxes, but most require that some tax liability is incurred on the sale of an appreciated property. In addition, each state has its own rules covering capital gains tax deferral. Most states mirror the federal taxation rules and
guidelines, but not all do.

The focus of this book is on federal taxation and those states, California for example, that mirror the federal rules. A state-by-state analysis is beyond the scope of this book, but I have included a list of the capital gains tax rates for the individual states in the appendix. Nevertheless, I suggest you see your local tax advisor regarding your state’s tax treatment of capital gains on the sale or exchange of property.

As previously mentioned, true income tax is scaled to tax larger incomes at higher percentage rates. Capital gains tax, however, is currently based on a flat 20 percent rate. This is the lowest capital gains rate in almost 40 years. And unlike other types of taxes, capital gains taxes can be deferred indefinitely and, in some situations, eliminated completely. In the next section, I look at the types of wealth increases categorized as capital gains.

Figure;


Capital Gains Tax Rates and Holding Periods


Date Property Sold                     Tax Rate                                       Required Holding Period



Before May 7, 1997                      28 percent                                      1 year +


On or after May 7, 1997                20 percent or 10 percent if             1 year +
And before July 29, 1997               taxpayer is in 15 percent
                                                      income tax bracket

On or after July 29, 1997               20 percent or 10 percent                18 months +
                                                      if taxpayer is in 15 percent
                                                      income tax bracket


Assets acquired on or                     18 percent or 8 percent                 5 years +
                                                       if taxpayer is in 15 percent
                                                      or less income tax bracket
after January 1, 2001