In the United States, the typical long-term rate for capital gains tax is 28.6%, when you merge local, state, and finally federal taxes together. That rate is higher than many countries within the Organisation of Economic Co-operation and Development (OECD), of which the U.S. is also a member. Californians alone pay the third-highest marginal tax rate among all OECD members; only nations like France and Denmark paying more money.
Many shrewd real estate investors already use some strategies for lowering their capital gains tax liability for real estate sales. The two fundamental rules are – a) hold a property for a year at minimum, and b) sell when your income falls to its lowest point.
In addition to these two pillar rules, there are some additional tactics you can use if you want to expand your profit potential further while avoiding additional IRS scrutiny. While each investor’s situation is different, you may be able to use the following strategies to generate more income, both long-term and immediate, through real estate asset protection.
Real Estate Asset Protection Strategies for Capital Gains:
Capital Gains Deferment – A battle has been happening between lawmakers and like-kind exchanges for nearly three years now. IRS Code 1031 enables investors to defer paying taxes on sale gains if they reinvest those earnings into a comparable property (also known as like-kind) within 180 days of closing. While there have been calls to repeal this legislation, a 2015 Ernst and Young study found that repealing it would significantly affect the US economy by lowering GDP due to diminished business investment. Calls for repeal and reform have been held back as a result.
Properly filing a like-kind exchange is done through IRS Form 8824. The information asked for includes data such as the specific dates of transfer and the like-kind’s value. You are required to fill out and file the 8824 within a 45-day grace period after the original property’s sale.
Using Charitable Remainder Trusts – The Tax Reform Act of 1969 created additional tax-exempt vehicles in charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). CRATs are tax-exempt trusts funded via cash or assets (in this instance appreciated property) and irrevocable. The income is repaid to the beneficiary (either yourself or someone else) through fixed payments over his or hers’ life or over a specified period not exceeding twenty years. When this term reaches completion, the remaining money is transferable to a charity of one’s choice.
CRUTs essentially work the same as CRATs except their payments are dispersed yearly in fixed percentages that range between six to fifteen percent of the assets’ value. CRUT amounts then depend on the assets’ market performance, i.e. if the market value increases then potentially, more income will be generated and paid out. Funding a CRT creates an immediate tax deduction for the trust donor based on the remainder interest that the chosen charity will receive at the specified term’s end.
Entity Structuring – The principal reason for sole proprietors to establish LLCs or other corporations is to protect their personal assets from lawsuits. A side benefit though is that entity structuring also plays a significant role in reducing capital gains taxes, making them fantastic real estate asset protection tools. In addition, using entities like LLCs, land trusts, and C corporations, when properly structured, also provides the savvy investor with a means to preserve anonymity from potential creditors, as well as reducing tax liabilities. Anderson’s team has extensive experience working in this area and has cultivated years of experience in knowing the correct combination of tools to use, depending upon a client’s specific goals and needs.
Despite the massive capital gains tax rates the United States imposes on its investors, including those with holdings in real estate, the strategies to still hold onto gains and minimize tax bills are available and useful. Real estate asset protection through entity structuring, charitable remainder trusts, or deferment is worth investigating for any real estate investors looking for both short and long-term profits. If you’re currently an investor who does not have their properties sufficiently shielded from potential lawsuits and creditors, then you owe it to yourself to speak with one of our advisors today through one of our free, 30-minute strategy sessions and get the answers you need now.