Tax Minimizing Strategies for Real Estate

Below is a discussion of several different tax minimizing strategies used in connection with the sale of real property

Private Annuity Trusts. Defer Cap Gains Tax on Sale of Property. If you are planning to sell real property that has significant taxable gain and don't want to pay all of the income tax immediately, consider setting up a private annuity trust. A private annuity trust authorizes the trust to buy the property, sell it to a third party buyer through an arms length transaction and then distribute the proceeds to the individual seller over her lifetime. This could yield thousands of dollars in tax savings

1031 Like Kind Exchanges. This allows the owner to sell his property for cash ("transfer"), identify another like-kind property within 45 days of the transfer, and buy the new property within 180 days of the transfer. Here's an illustration of one way a like-kind exchange can save the taxpayer money. Owner buys an apartment building for 500,000 in 1980. Owner depreciates building entirely. Owner's adjusted basis in the building, therefore, is $0. Owner sells his building in 2004 for $3,000,000 in a like-kind exchange and buys replacement property for $4,000,000. Owner dies in 2005. Owner's beneficiaries get to step-up the entire basis on Owner's death. Thus, if beneficiaries sell the property for $4,000,000 dollars, they will not have any taxable gain in the building. No income tax!!! This would result in a net $450,000 federal income tax savings

Understanding Property Tax Laws. I have had several clients call to tell me that their friends were able to sell their homes at a premium and transfer their property tax basis into their new home, thus avoiding higher property taxes. They want to know how they can do the same. Since there is a lot of confusion about California property tax laws, I thought I'd briefly explain some of the more important propositions

a. Proposition 13: Proposition 13 prohibits the county taxing agency from increasing a property's assessed value to more than 2% each year. To illustrate, Jane buys her house for $500,000 in year one. Jane pays $5,000 in property tax, or 1% of its assessed value, which is equal to the purchase price. In year two, she refinances her house and has it appraised at $550,000. In year two, her property tax may not exceed $5,100 (1% of $510,000) even though most other states would assess her $5,500, or 1% of her house's fair market value. Over time, Jane realizes an enormous benefit compared with a more recent purchaser of similar property. In year three, Jane sells her house for $600,000. The County will assess the third party purchaser a tax equal to 1% of $600,000, or $6,000. Possible Exception: Jane either gives or sells her house to her children or grandchildren

b. Proposition 60: Proposition 60 allows a homeowner to transfer the existing tax base of his old home to his new house, but only if:

  1. The new home is of equal or lesser value than the old home;
  2. The owner is at least 55 years of age.
  3. The new home is purchased within two years of the old home's sale.
  4. The homeowner hasn't used this exemption before
  5. The homeowner moves to the same County.

c. Proposition 90: This allows the homeowner to take advantage of Proposition 60 even if he moves to another county so long as the County participates in this program. Counties that participate include Orange, San Diego, Los Angeles. Note Riverside's conspicuous absence.