How to Avoid Property Capital Gains Tax

If you had capital gains while a resident of the United States, you are almost certainly subject to capital gains tax. Capital gains tax rates are significantly lower than income tax rates (the maximum rate is 15 percent in most cases) to provide an incentive for investment. U.S. tax law provides a number of ways to avoid capital gains tax on all types of property, including stocks and bonds, personal property, and real estate. In some cases this simply means deferring your capital gains tax liability, while in other cases, it means eliminating or greatly reducing your overall liability.

Difficulty: Moderate

Instructions

1. Make gifts of your stocks and bonds to your adult children. Transfer these securities to your childrens' names and sell them. There is a $11,000 limit per year (per child) on such gifts; a gift tax will be imposed on you for any increment over $11,000 that you gift. Keep in mind that if your spouse owns stocks and bonds, your collective gift tax limit is $22,000 per child. When these stocks and bonds are sold, the capital gains tax will be only 5 percent

2. Buy real estate of greater value than any real estate you sell during the same tax year. You may then subtract the purchase price from the sale price, cancelling out your capital gains and perhaps leaving you with a significant net capital loss to carry over to the following year.

3. Reduce capital gains on rental property by moving into the property for at least a year before you sell it. When you switch from being a landlord to a resident, you can take advantage of the primary residence exception in the tax code and wipe out most of your capital gains tax liability from the sale of the property.

4. Finance the sale of your own property (real estate or personal property) by allowing the buyer to pay in installments. Capital gains tax will only apply to the income you receive during the tax year. Furthermore, if you have carried over capital losses from previous years, you might end up owing nothing.

5. Execute a "1031 Exchange." A 1031 Exchange is essentially a property swap. As long as the properties that are traded are of "like kind" as defined by the IRS, you can defer capital gains until actual income is realized. Stocks and bonds cannot be traded in this way, and a few other exceptions apply to certain kinds of personal property. Real properties are almost always considered "like kind" unless one of the properties is located outside of the U.S.. Personal properties are considered "like kind" if they are of the same general class (automobiles, for instance).

Tips & Warnings

• If you gift stocks and bonds to your children, but still want to maintain control of them (in order to prevent them from disposing of them and using the money contrary to your wishes), you can set up a trading account in your children's name and have them grant you complete trading authority.
• If you finance the sale of your own property in installments, you are taking the risk that the buyer may default on payments. While you will still have the option to foreclose, it could be expensive and time-consuming. Carefully consider whether this risk is worth the tax savings.

Resources

• IRS Form 1040, Schedule D (Capital Gains and Losses)

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on 5/26/2009 5*'s