When you sell real estate, your business, a patent, or stock in a privately held company, capital gains tax will play a significant role.
Depending on the state in which the asset is sold, the tax can vary dramatically. As an example, assets sold in Washington will have a base tax of 23.8%. In Oregon, the base is 33.7%, in California, the base is 37.1%.
The good news is that the IRS allows for alternatives when addressing your capital gains tax obligation. You have two basic choices. You can pay the tax in the year of the sale, or you can defer the tax to some future tax period.
There are over a dozen different deferral options listed in the 70 thousand pages of tax code. Many people who have sold or bought investment real estate are familiar with the deferral option known as IRC 1031 Exchange.
This is an excellent option for real estate sellers who are interested in acquiring another piece of real estate. In simple terms, it allows the seller to defer their tax by transferring their ownership to another property. In turn, the seller can defer the tax obligation to a future date.
However, IRC 1031 Exchange, is only available for real estate transactions. How do you defer your tax if what you are selling is not real estate? One of the other tax-deferral options might be the answer.
As an example, people selling a business, patent, or private stock sale often utilize IRC 453 & 453(A) Installment Sale with Monetization Loan. This deferral option will also work for a real estate sale where the seller does not want another property but would like to defer the capital gains tax.
I am often asked which deferral option is best? The answer to that question is dependent on the seller. What is the goal of the seller, along with the math and structure of the sale itself? Every deferral option has a value under the right circumstances.
Because many CPAs, financial planners, and tax professionals, have limited familiarity with the IRC 453 & 453(A) the following is a basic outline of that option.
The most important thing for a seller is information. The more they know about their deferral options the better equipped they are to make an informed financial decision.
(IRC) 453(A) Installment Sale with Monetization Loan
The correct implementation of IRC 453 allows the asset seller to receive their money in a tax-free loan at closing, while deferring their capital gains tax obligation for 30 years.
Utilize a Qualified Intermediary (QI) the same as a Facilitator in a 1031 Exchange.
Asset Types to be sold: Real Estate, Business, Intellectual Property (patents), Private Stock Sales.
Loan Type: Uncollateralized, limited recourse, 30 years in length. P&I payments come from the QI, not the seller.
Seller Protection: Seller is protected from actions or financial failures of either the QI or Lender.
Use of Loan Proceeds: Seller (Loan Recipient) can invest the proceeds in a fashion they deem appropriate.
Value of a Tax deferral: The financial value comes from the basic ‘Time Value of Money’.
Example: Assume an asset sale resulting in a $1 million tax debt. Seller could pay the IRS $1 million, or invest the $1 million for 30 years then pay the tax.
If Seller dies before the end of 30 yr. deferral. The deferral continues. The beneficiaries pay the tax in 30 years and reap the rewards of the investment.
If IRC 453 & 453(A) or another deferral option might help you accomplish your goals, please contact us. We focus exclusively on capital gains tax issues.
Contributed by Jack Gruber