Just for the record, holding note is a fine option if you have held the property for a while. However if you are flipping properties via holding note, beware. IRS can declare you a dealer and require income tax on all your profit in the year of the sale, regardless of the fact you haven’t actually seen the money because it is coming in via long term note.
Also, you still have to pay tax on your profit and interest via the note, just not all at one time.
What to do with Equity from Rental - Posted by Albert Garibay
Posted by Albert Garibay on January 10, 2003 at 19:34:09:
We will be selling a rental property in the near future. There will be a profit amount of $75,000.00.
I have advised my wife that only 1 of 2 options are available to us regarding the profit from the rental.
1-pay uncle sam his fair share, 2-invest in another rental property of equal to and/or the original selling price.
Are there other options available. We don’t want to pay Uncle Same over $25,000.00 from the profit.
We will be retiring in 2 years. We sure would like to hold on to as much money as we can. Thanks
Well, if you would consider owning more investment real estate rather than paying the taxes, it makes sense to me to continue to own it and not sell it. Now, perhaps you have some reason to feal that this particular property is not a good investment for you anymore and that you can find some other property that is better for you. If so, yes, you can sell and do a tax-deferred exchange.
And the rules for an exchange are not as you have stated them. If you want a completely tax-deferred exchange, you just have to buy a property for more than the net sales price of the current property and end up having loan amounts greater than that on the given-up property. There in nothing about the purchase price of your old property to even consider. And, if you are willing to settle for a partial tax deferred exchange, you could buy a property for less than the selling price of the current property. You’d pay taxes on the part of the sales price you don’t have reinvested into the new property.
John suggests selling and carrying back paper on the sale. This is certainly an attractive option for a lot of people in your position. You would be getting payments which would be composed of several parts.
return of your investment – no taxes owed
the gain on the sale – capital gains taxes owed, as the gain is “realized” or received over time–spread out over many years perhaps
interest on the loan – taxed at ordinary income rates.
But notice one thing here: you would be getting interest on all the equity you left in the property as a carry-back loan for the buyer. Suppose, for example, you sold it with no down payment–perhaps having a second note secured on some other property owned by the buyer to give you more security. Now, you would be getting interest on a $75K loan. You would be getting interest on 1 1/2 times as much loan amount as you would get if you sold the property outright, paid $25K in taxes, then reinvested the remaining $50K in a mortgage note. What is happening is that you are charging your buyer interest on the part of the equity which belongs to the government–in the form of taxes you will owe on the sale. So, you get 1 1/2 times as much income off your investment equity as you would if you sold out and invested in a note. And the government will not care. As long as you set it up properly. It is done all the time. It is called an “installment sale” election.
Posted by John J. on January 10, 2003 at 21:44:04:
I have sold several properties with a low down payment and carried the contract. I get a higher sales price and a very good interest rate on my gross equity (before the capital gains taxes are to be paid). Of course there is a risk with this option. A lower risk variation of this is to do a lease option on the whole building.
Another option is to set up a charitable remainder trust. The development office of your favorate university or charity will be glad to help you with this.