By JEFF LAZERSON / CONTRIBUTING COLUMNIST
Because we are at or near the top of the Orange County median price mountain, consider just selling your rentals because the available inventory for 1031 purchase exchanges is superpricy.
If timing is everything, what about waiting for the potential of a capital gains tax cut by President-elect Donald Trump?
“It is widely expected that Trump will reduce capital gains income tax. So if you can delay recognition of gain on sale, it would be wise to do so,” said Irvine CPA Macelo Sroka of Sroka & Co. CPAs.
You have to pay capital gains tax if you’ve held a property for at least one year and you’ve made a profit. Tax rates run from 0 to 20 percent, depending on your adjusted gross income.
Higher-income earners will have an additional Obamacare tax of 3.8 percent (of their net investment), according to Irvine-based tax attorney Rod Stern of Murtaugh, Meyer, Nelson and Treglia.
You don’t pay tax on the original principal you invested.
Consider three ways to sell your rentals now and delay some or all of your capital gains taxes. Any income generated from the sales proceeds is taxed as ordinary income.
The first one is a deferred sales trust. The property owner concurrently sells the rental to an unrelated trust and the trust sells the property to an unrelated buyer.
This is typically done using a listing realty agent to market and sell the property.
With input from the property seller about stocks or mutual funds (for example) for the trust to invest in, the trust holds and invests the net amount received after the property sale is completed. The property seller carries back a loan note from the trust, according to Robert Binkele, CEO of the Estate Planning Team.
This trust creation costs 1 to 11/2 percent of the net amount received on the sale. Plus, the trustee will charge approximately 1/3 of 1 percent as an annual fee and the annual investment management charge, according to Dan Maughan, financial consultant at Financial West Group.
The second one is a charitable remainder trust. That can set up income for life for you, your children or anyone that you name, family or not. It costs from $5,000 to $15,000 to set up.
You can manage it yourself, bypassing management fees. Whatever assets left after the last death goes to the charity that you named up front, according to Stern.
The last one is an installment sale. This is classic seller financing. The seller and buyer agree on an interest rate for the mortgage note over a certain period of time. In this case, you can delay some capital gains by doing an interest-only note. If the buyer defaults, you’ll have to foreclose.
Always consult your tax adviser before making any decisions.
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Jeff Lazerson - Mortgage Columnist since 2011