capital grain tax

[mannydoall]

Do I avoid paying capital grain tax on the sale of an investment property if I owner finance it to the buyer? I will receive a 20% down payment.   

[mcwagner]

No.  A method of financing never "avoids" the tax on income.

If the property is a flip, then the gain is not capital.  It should be treated as business income from the sale of inventory, which is ordinary income subject to income + self employment taxes (total tax ~ 45%).

If the property was a rental, then the gain is capital.  You may defer part of the gain if you elect to treat it as an installment sale.  You will also have annual interest income and should provide the buyer with a form 1098.

[mannydoall]

I purchased this condo 5 years ago and the value has triple. I have been renting it until now and it is free and clear. I am tiered of dealing with tenants so I think I would have less tax lost financing it to a buyer, paying capital grain on the 20% and on the income. Dont you think If I sell it out right the tax cost would be greater.

[BLL]

Sell it out right and buy a TIC using a 1031 exchange. There will be no tenants and no capital gains unless you sell.

[Dave T]

I purchased this condo 5 years ago and the value has triple. I have been renting it until now and it is free and clear. I am tiered of dealing with tenants so I think I would have less tax lost financing it to a buyer, paying capital grain on the 20% and on the income. Dont you think If I sell it out right the tax cost would be greater.

As a general rule, if you only consider the profit from the sale, you will have the same tax liability in either case.  The difference is that with the installment sale, you get to pay your tax bill in installments over time.  With the outright sale, you pay the tax bill all at once.

If taxable gain that you would declare in the outright sale puts you in the Alternative Minimum Tax zone, then the installment sale may be better for you.

On the other hand, in 2011 the long term capital gains tax rate is scheduled to increase from 15% to 20% (unless Congress intervenes in the meantime).  Installment sales are taxed at the rate in effect in the year the income is received.  It is possible that some portion of your sale profit will be taxed at 20% if you use the installment sale, while it will be taxed at 15% (at most) if you sell outright today.

[mannydoall]

Those are great advice. I am thinking that the interest I receive by financing the sale will off set some of the tax debt I will incurs in the long run. Unless the buyer decided to pay me off right away, I will make double  his purchase price in interest.

[Dave T]

Interest income does not cancel capital gains profit. 

If you finance the sale and charge interest on your loan to the buyer, a portion of each installment payment will be capital gain and a portion will be interest income.

The interest income is taxed at your ordinary income tax rate, while the capital gain will be taxed at the long term rate applicable to the tax bracket in which the capital gain is earned.

Yes, the interest income you receive can be used to pay the capital gains tax liability you incur on the sale, but I just wanted to be sure that you understand that the loan interest is also taxable.

You say this is investment property.  How long have you owned it, and, what did you do with the property while you owned it?  The answers to these questions may change my answer to your tax treatment question.

[mannydoall]

I own this investment property for 6 years as an income rental. It has been a good positive cash flow but recently special assessment are starting to make me worry. I would like to get out while I am ahead. Thanks.

[Dave T]

I understand your concern.  I have quite a few condos in my own rental portfolio.   If a special assessment is needed becuase the master insurance policy premium suddenly doubled, then that is understandable.  The condo board can make the appropriate budget corrections and adjustment your monthly fee next year.

If this is the reason, I would not be too concerned.  Over time, your annual rent increases will let you recover some or all of your out of pocket costs for the special assessment.

If the assessment is needed to make repairs that should have been anticipated well in advance and funded from a replacement reserve, then I would have concerns about your association's management.  In this case, I would be more inclined to sell the property if there is a market.

Since this property was used as a rental, you were allowed a depreciation expense on your Schedule E each year of rental use.   Whether you sell on installment or outright, your sale profit (when received) is first applied to unrecaptured depreciation, and then to capital gains due to appreciation. 

Let's say you are selling for $50K more than you paid for the property and you were allowed $21K in depreciation.  The first $21K in taxable gain from the sale will be due to depreciation that did not really occur and will be taxed at 25%.  The rest of your sale profit will be long term capital gain and taxed at the rate that applies to the marginal tax bracket in which the income is earned.