I bought a vacation home for $1 million in 2000 and it has doubled in value. How can we avoid capital gains tax?

Dear Big Move,

My husband and I plan to sell our vacation home in the next 12 months. It has appreciated considerably since I bought it. We are looking at ways to defer some of the capital gains tax.

The property is located in California. There are actually two adjacent lakefront properties that I purchased in 2000. I paid $950,000 for the lot with the house and $225,000 for the adjacent, vacant lot. Based on recent sales in the area, both properties have at least doubled. We are exploring route 1031 for the empty land that remains undeveloped.

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We would appreciate it if you could delineate the pros and cons of doing a structured installment sale using an annuity, as well as the tax treatment of annuity payments.

House salesman

Dear seller,

After owning that property for nearly 30 years, you’re facing a huge tax bill when you sell, so it’s understandable that you’d want to find a way to defer paying the taxes until later.

A quick capital gains recap: Your capital gains tax basis when you sell your property will be your ‘cost basis’ – that is, the price you bought your property for, plus the cost of any improvements. The capital gains tax is $250,000 for single filers and $500,000 for married taxpayers filing jointly).

The bad news: This is your vacation home. You can only qualify for an exclusion if this has been your second primary home for the past five years and you meet other requirements (you can read more here from the Internal Revenue Service).

So here’s the good news. “There’s more than one option to consider,” says Matthew Chancey, certified financial planner and author of Tax Alpha Solutions: Effective Tax Management Strategies For High-Net-Worth Investors.

Here are two ways:

The annuity path

An annuity is an investment issued by insurance companies that helps you build a guaranteed stream of income.

When you buy an annuity, you pay a lump sum up front or make payments over a period of time in exchange for a promise from the life insurance company to pay you a guaranteed income over time, says Dan Finn, a Newport Beach, California. financial advisor at Finn Financial Group.

A lump sum payment is required in advance for structured installment sales. “A structured installment sales annuity can provide sellers with guaranteed payments over a designated period,” according to MetLife MET.

“This structure allows the seller to defer their capital gains tax and potentially reduce their overall tax liability on sale,” the company adds. “This results in a tax-smart stream of guaranteed income.”

With this route, you effectively spread your proceeds from the sale of the home over several years, so you reduce your taxable income for the year. You split the tax liability as long as you structure it so that each payment consists of several elements: your cost basis, depreciation recapture—the difference between the sales price and the depreciated costs—and capital gain.

Depending on your other forms of income, this gain could fall into lower brackets and be taxed more lightly, depending on how long you spread out the structured payments, he adds.

Here’s how it works: If you get a million dollars from the sale, instead of getting the entire amount in one go, you and your home buyer agree to terms that become part of the purchase and sale agreement. You should consult a structured installment sales expert during this process.

“The parties then agree (that) the buyer’s obligation to make those payments is transferred to a third-party assignee, who then purchases the desired annuity from the life company using the proceeds of the sale,” says Finn.

The internal rate of return on such annuities is low, and payments are not flexible once they’re set, Chancey adds.

Finn, however, rejected that claim, arguing that the return would depend on “the deferral, duration and rates prevailing at the time of financing” and that the rates were commensurate with other investments of similar risk. “Additionally, fixed-term securities have recently had higher yields than they have in decades,” he says.

“This is a great procrastination strategy,” he adds.

Route 1031

Another route you can consider: the 1031 exchange. “The simplest type of exchange under Section 1031 is the simultaneous exchange of one property for another,” says the IRS.

Essentially, when you sell an investment property, you must pay taxes on the gain at the time of sale, but there are federal tax guidelines that allow you to defer paying that tax if you reinvest the proceeds in a similar property. To be clear, you are not avoiding taxes, just deferring them by doing a 1031 exchange.

Not only are you 100 percent tax-deferred, but upon your death, your heirs will receive everything tax-free, and you’ll also be able to capture any additional appreciation in the home’s price as property values ​​rise, says Edward Fernandez. , President and CEO of 1031 Crowdfunding.

But to do a 1031 exchange, you’d have to rent the home for the next two years to a tenant for it to count as an investment property for tax purposes, Chancey adds. After that, you can do the 1031 exchange and defer taxes, “but also have all the money locked up in real estate,” he says.

Good luck with the sale.

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I bought a $180,000 house for my daughter. He got married and moved away. Now I want to sell. How do I avoid capital gains taxes?

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