Part 2: How to Reduce Capital Gains Tax When Selling Your Home

2 Strategies to Avoid or Reduce Capital Gains Tax

In our previous blog, we discussed how to avoid capital gains tax on Bay Area single-family homes, which have roughly quadrupled in value over the past 25 years. In 1999, the average single-family home in San Mateo County sold for approximately $600,000. Today, that average has soared to $2,500,000, especially in communities like San Carlos and Redwood City. While this increase benefits those who purchased their homes years ago, many long-term homeowners now feel trapped by the substantial capital gains taxes they would face if they decided to sell.

Over the past 25 years, the average single-family home has appreciated by $1,900,000. Even with the $500,000 exemption for a married couple, $1,400,000 remains subject to taxation. Between capital gains and state taxes, a married couple would likely face around $500,000 in taxes (approximately 35%) if they had bought their home 25 years ago. The prospect of a $500,000 tax bill leaves most people feeling paralyzed.

There are two common ways to either reduce or outright avoid capital gains taxes. Here we will discuss Strategy #2: Reducing Capital Gains Taxes.

Strategy #2: Reduce Capital Gains Tax

Unlike the 1031 Exchange strategy we discussed previously, this strategy does not require you to rent out your home and wait four years to move into your new place. Instead, you sell your home and can keep some cash tax-free, with the remainder going into an annuity. In the above example, a married couple could sell their home and keep $1,100,000 tax-free ($600,000 purchase price plus the $500,000 exemption). This amount could be used to buy a new home in a less expensive area, invest it, or save it.

Structure an Installment Sale

Assuming your old home was fully paid off, you would still have around $1,250,000 left after paying the selling costs. This amount, considered pure profit, would be subject to taxes. By placing this amount into a structured installment account, it can be paid back to you over a period of 3 to 40 years, depending on your preference. The key is to keep the annual repayment amount low enough to stay in lower tax brackets.

For example, if you keep your annual repayment below $500,000, you could reduce your capital gains taxes by about 10% (from 35% to 25%). If the proposed Biden tax increases occur, you could save even more.

If you opt for a low repayment of $47,000 per year or less, you would pay zero federal taxes, only state taxes. This strategy allows you to get some money upfront without taxes, reduce the taxes owed on the remaining amount, and avoid becoming a landlord for your old home.

Other Important Considerations

• Fixed Terms: Once the annuity terms are set (repayment period), they cannot be changed.
• Modest Return: The annuity return is around 4% per year.
• Buyer Cooperation: Some cooperation from the homebuyer is required, which demands finesse.

Contact Us Today

If this sounds interesting, call us, and we can help formulate a strategy that works best for you. These tax strategies require the involvement of specific professionals, and we can connect you with the right experts.

Please consult with your accountant to understand how a 1031 Exchange or structured installment sale would impact your unique tax situation and to stay updated on frequently changing tax rules.