If you sale a property, you are liable for tax on the gains earned out of the sale. You can use capital gains calculator on this site for a quick estimate of tax iability.The question is can you defer gains so that you don’t have to pay any tax on the capital gains earned during the year ? The answer is a definite yes . There are at least three ways , as described below , that allows you to defer the gains for a specified period of time.
- by selling the property in an installment sale,
- by exchanging the property for another popularly known as Tax -Deferred Exchange , or
- by investing in a qualified opportunity fund. As with all tax strategies, these options have unique requirements.
Let us discuss each on of them.
Installment sales of a real estate property mean you are providing the buyer with your property on credit or as if on loan. So you receive not only the yearly payment of the principal amount but also receive interest on the loan.You then pay income taxes only on the down payment and any other principal payments received in that year and the interest received from the buyer.
Points to note about selling by installment
- the instalment sale method cannot be used for the sale of publicly traded stock or securities.
- The installment sale provisions also do not apply when the sale results in a tax loss.
- If the sold property is mortgaged, the mortgage must be paid off as part of the sale. Even if the seller does not have the financial resources to pay off the existing loan, an installment sale may be possible if the seller takes a secondary lending position or includes the existing mortgage in the new loan.
This method is popularly known as “tax-free exchange,” or also known as “1031 exchanges,” in reference to the tax code section IRC Sec. 1031. So under this section, the tax on capital gain is deferred till you sale the property changed for. So, one should note that the capital gain will eventually be taxed when that property is sold (or will be deferred again in another exchange). After the Tax Cuts & Jobs Act , certain changes have been brought to 1031 exchange rules. One exception to this rule is that U.S. property cannot be exchanged for foreign property. You can read 1031 Exchange Rules Modified : Here Is A Fresh Look On Section 1031 .
There are certain procedure and rules that must be followed for the proper 1031 Exchange. Please read Accomplish 1031 Exchange in 8 Steps!
Import to note is the term Qualified Opportunity Funds. This method only works if the investment is done in a Qualified Opportunity Fund which was conceptualized and enacted under Tax Cuts and Jobs Act . TCJA provided that individuals who have capital gains from the sale of a personal, investment, or business asset can temporarily defer those gains into a qualified opportunity fund (QOF) which is intended to promote investments in certain economically distressed communities, or “qualified opportunity zones.” Please read Qualified Opportunity Fund (QOF) : New Way To Defer Capital Gains