Are you trying to sell investment or commercial real estate? If you use an installment sale to help sell real estate, you can benefit from tax deferral and possibly lower your overall tax bill. But watch out for a little-known tax trap.
Here’s what to know
Generally, installment sale treatment is automatic for a sale where you receive payments in the tax year of the sale and at least one other tax year. For instance, if you sell real estate in 2017 and receive payments in both 2017 and 2018, you qualify. Part of the tax due on your gain is taxable in 2017 and part is taxable in 2018.
Note that real estate held longer than one year qualifies for favorable treatment of the capital gains tax. The maximum tax rate on long-term capital gains is only 20 percent, compared with the top ordinary income tax bracket of 39.6 percent.
Why an installment sale may be worthwhile
With an installment sale, you may benefit from the lower tax rate in several years by spreading out payments over time. This reduces your overall tax liability.
Caution: If you sell property to a related party that is then disposed of within two years, all the remaining tax comes due (barring certain exceptions). The tax law definition of “related parties” is more expansive than you might think. It includes:
- A spouse
- A partnership or corporation in which you have a controlling interest
- An estate or trust you’re connected to
Avoid any dire tax results by stipulating in the contract that the property can’t be disposed of within two years.
Finally, be aware that installment sale treatment is only available for gains, not losses. Other special rules may apply, so give Carl Heinemann, your Chattanooga CPA, a call and we can take a look at your specific your situation.