Here’s a unique tip on how to sell a house fast and pay very little capital gains tax – use an installment sale.
Let’s say you want to sell your home. You bought it several years ago and you have a lot of equity in the property. Your luck doesn’t stop there. You’re fortunate enough to actually find buyers. The only problem is, they can’t meet the stringent
requirements that banks are now imposing to qualify for a loan. On top of that, you’re not really excited about paying the capital gains tax on all that appreciation. Here’s a solution that can help draw in more buyers, help more buyers qualify for the purchase and reduce your tax problem all at the same time.
Too good to be true? No. It’s called an installment sale. It could turn your home into one of the best investments for retirement income you could find. Under this maneuver, you extend a loan to the buyer. This can be a first or second mortgage. As the buyer makes payments, you recognize (and pay tax) on the gains proportionately. Let’s use an example.
You bought your home 25 years ago for $50,000. Now, you sell it for $400,000. Your total gain on the sale is $350,000.
But that’s not your taxable gain. That’s because the first $250,000 is tax-free if you’re single ($500,000 if you married). So, your taxable gain is $100,000 ($400,000 – $250,000 – $50,000). That means 25% of any money you receive is a taxable gain and 75% is tax-free.
The buyer puts down $100,000 and you take back a mortgage for $300,000. The monthly payments will be $4,000.
When you receive the $100,000 from escrow, you recognize 25% of it ($25,000) as a capital gain and the other $75,000 is tax-free.
Then, each month, as you receive the $4,000 payment, you recognize principal and interest. 75% of the principal you receive is tax-free, 25% of the principal will be taxed as a capital gain and any interest is taxable interest.
As I said, there are a number of advantages for the seller. First, you defer the tax on the sale. In essence this allows you to use the government’s tax money to earn interest for yourself.
Also, with rates so low, you would probably earn much more interest by doing this than by plopping all that money in the bank. It’s a good way to generate income during retirement.
Also, you open the market to a much greater number of buyers. Nice.
Negatives to Using an Installment Sale
First, we don’t know what the tax rate is going to be in the future. My guess is, it’s going up. If that’s the case, you might pay a higher tax rate on the gains (and income) than you would if you paid the capital gains tax now.
Also, you don’t have use of the cash. If you need the money to buy another home, this technique won’t work. You also take the risk of the buyer being a flake and then you having to sweat out the foreclosure process. If you are uncomfortable with collecting money owed to you if things go wrong, don’t get started.
With property values and interest rates low, I think this could be great for certain people.
Would you sell your home in an installment sale? Have you ever done something like this or know someone who has? How did it work out?