Sell Now and Pay the Taxes Later
By Jeffrey S. Watson
One of the biggest challenges real estate investors have when they hold a portfolio of properties and are tired of the “thrill” of management is the fear of taxes when they choose to sell some of the properties. Let me be clear. I’m not advocating that investors sell everything in their portfolios. I’m saying that they need to determine if they should sell the bottom tier of their portfolios to eliminate most of their headaches. The “80-20 rule” is real, which is that 80% of your headaches will come from 20% of your properties. Those are the ones you want to think about selling.
When you sell using seller financing, you can elect to treat it as an installment sale, which is the sale of property in which you receive at least one payment after the tax year of the sale. If you choose to treat a sale as an installment sale, and it qualifies as such (that means you can’t be a dealer), the gain must be reported under the installment method. Each payment consists of three parts: interest income, return of your adjusted basis in the property, and gain on the sale. This means your basis and gain are spread out over all the payments you receive. On a 20-year note, you are going to spread the return of your basis and the recognition of your long-term capital gain over 240 payments.
I’m going to stop there because I recommend that you either read IRS Publication 537 or meet with your tax professional since I’m not a tax professional (nor have I stayed at a Holiday Inn recently!). What I can tell you is that I’m not a dealer in real estate, and the installment sale method is what my accountant is going to be using on the properties I have sold, so I can then defer a lot of my gain over the next 30 years.
If converting rental properties into seller-financed notes is something you are interested in and want to know more about, please send me a note so I can share with you what I’ve been doing in my own business and what some of my clients are having great success doing as well.
Jeffery S. Watson is an attorney who has had an active trial and hearing practice for more than 25 years. As a contingent fee trial lawyer, he has a unique perspective on investing and wealth protection. He has tried over 20 civil jury trials and has handled thousands of contested hearings. Jeff has changed the law in Ohio four times via litigation. Read more of his viewpoints at WatsonInvested.com.
