If you use an installment sale to help sell real estate, you can benefit from tax deferral and potentially lower your overall tax bill. But you need to watch out for certain tax traps if you do.
What Is an Installment Sale?
You create an installment sale when you receive payments for sold property in the tax year of the sale and at least one other tax year. For instance, if you sell real estate for a profit in 2017 and receive payments in 2017 through 2021, your real estate transaction is an installment sale.
An installment sale creates a tax event in each year you receive payments. In the above example, part of your gain is taxable in 2017 and each year through 2021.
Be aware that real estate held longer than one year qualifies for favorable capital gains tax treatment. The tax rate on long-term capital gains is from 0 to 20 percent, compared with the top ordinary income tax bracket of 39.6 percent.
You could also to pay all the tax due on the sale upfront, to avoid paying tax on the installments in future years. In some cases, you'll reduce your overall tax bill this way, though it may require some help with tax planning.
Benefits of an Installment Sale
With an installment sale, you may be able to lower your total tax on the sale of the property by spreading this income out over several years. In addition, the buyer will typically pay a rate of interest to you higher than a typical bank loan for the rest of the amount due.
Installment Sale Tax Traps
Related parties caution. If you sell property to a related party and the property is then disposed of within two years, in most cases, all the remaining tax comes due at once. The tax law definition of “related parties” is more expansive than you might think. It includes:
To avoid this major tax surprise, consider stipulating in the contract that the property can’t be disposed of within two years.
Depreciation recapture potential. Also be cautious if you took any depreciation on the property in prior years. In some circumstances you will owe extra tax related to that depreciation when you sell the property.
Gains not losses. Be aware that installment sale treatment is only available for gains, not losses. Other special rules may apply, so reach out if you need advice specific to your situation.
Of course, tax reform discussions now in Congress might impact how installment sales and long-term capital gains are treated. If you're planning an installment sale, consider contacting Ellsworth & Associates for a consultation to discuss the tax implications.
Suppose you retire to a new state with warm weather and lower taxes. If you keep a part-time home in your original state or you later decide to return, you could have a tax problem. State tax authorities may argue you never really left, and that you owe them a big tax bill for all the income you earned while away. Here are tips to ensure this does not happen to you.
Tax residency is usually based on the concept of "domicile." You may have many homes, but you can only have one domicile. A domicile is the place you intend to be your permanent home, and where you intend to return after being away. When these cases go to court, they are often decided by determining a person's intentions regarding their domicile. Consider this hypothetical example:
Illinois resident Steve Seeyoulater moved to an apartment to pursue a lucrative job opportunity in Indianapolis, leaving his wife and children behind in Chicago. Steve reasoned that since he spent more than 70 percent of his time in Indiana, he could file his state return there and take advantage of its lower tax rate. The state of Illinois could easily disagree with Steve's assumption, since on the surface Steve intends for his permanent home to remain where his family is, in Illinois.
Know the rules before you move
Before moving, research the residency rules in your home and destination states. They often vary from state to state. Some states have specific guidelines on the number of days its residents must be in the state. Others are less exact.
Keep good records
If you say you are in a state for a certain period of time, be ready to support your claim. If during an audit your credit card receipts conflict with where you claimed to be at the time, you will have problems.
Demonstrate your intentions
If you're going to file as a resident of a new state but also have a potential tax claim in another state, you have to be able to demonstrate your sincere intent to change your domicile. Here are some things you can do:
Renting an apartment or condo, leasing a piece of equipment, renting business property, or leasing a car all involve the common practice of borrowing something that is owned by someone else. This experience can easily become a nightmare with a bad landlord or if you don't understand your obligations. Here are some tips you can use to become a smarter renter.
If you rent rather than own a home, you could be missing out on tax benefits that favor home ownership. The current low interest rates make the cost of getting a mortgage relatively inexpensive, despite U.S. house prices at record highs.
Whether you decide to wait for the housing market to cool, or wish to take advantage of low interest rates while they last, take these tax benefits of home ownership into account:
Buying a home is a complicated decision, especially in a seller’s market. But the tax savings over time can be significant. If you need advice on this or other tax-related matters, don’t hesitate to call.
It's not an easy time to buy a house, but it can be done. Nationwide, US house prices rose to their highest levels ever in November and have stayed elevated, according to the Case-Shiller Index tracking single-family home sales. Residential inventories also reached their lowest levels on record during the first three months of 2017, the real estate data site Trulia reported.
With high prices and low supply, homebuyers have to tackle the buying process differently than they would in a flat or down market. If you can, it may be worthwhile to wait to buy a house until the market cycle changes. However, that's not always an option.
Preparation Is Key
In a seller's market you'll be competing with other motivated buyers for the house you want, so there's a benefit to acting quickly. If you take these steps to prepare, you can be fast and competitive without being frantic.
Land Your Dream Home
Your finances are ready; you've researched what you want; and you secured the help you need. Here are the next steps to landing your dream home in a tight market.
There are many resources available to you to navigate the home-buying waters. Spend some time finding the resources that work best for you and your situation.