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

2 Strategies on how to Avoid or Reduce Capital Gains Tax

In our previous blog about avoiding Capital Gains Tax, we discussed how Bay Area single family homes have about 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. This is particularly evident in communities like San Carlos and Redwood City. While this dramatic increase is great news for 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 altogether. Here we are going to discuss Strategy #2: Reduce Capital Gains Taxes.

Strategy #2: Reduce Capital Gains Tax

Unlike the 1031 Exchange strategy we discussed last time, here you do not have to rent out your home and wait 4 years to finally move into your new place. In this strategy, you sell your home and you can keep some cash but not all. The cash you keep can be tax free and the rest goes 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 could be used to buy a new home in a less expensive area, invest it or hide it under your mattress.

Structure Installment Sale

Assuming your old home was fully paid off, then you still have around $1,250,000 left over after paying the selling costs. This amount would be pure profit subject to taxes. This amount would then be left in the structured installment account. Here, the $1,250,000 would go into an annuity that could be structured to be fully repaid back to you in 3 – 40 years; whatever you desire. The trick here is to keep the amount you receive per year low enough to keep you in the lower tax brackets.

If you decide to keep your annual repayment below $500,000 then that would reduce your capital gains taxes by about 10% (from 35% down to about 25%). If the Biden proposed increases were to take place, then you would be saving much more.

If you could accept a low repayment of $47,000/year or less then there would be zero Fed taxes to pay; only the State taxes. Again, the strategy here get some money upfront without taxes, reduce the taxes owed on the remaining amount, and not become a landlord for your old home.

Other Important Considerations

Once the terms of the annuity are set (how long for repayment) it cannot be changed. The return on the annuity is around 4%/year which is modest. Finally, there is some cooperation required from the people purchasing your home which requires some finesse.

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 very specific professionals and we can bring them into the conversation to assist you.

Please check with your accountant how a 1031 Exchange would impact your unique tax burdens and for updates on tax rules which often change.

About the Author

Mark Martinho and Vivienne Kelvin are are among the best realtors in San Carlos CA and the co-owners of Vabrato, a luxury real estate brokerage serving San Carlos CA in San Francisco’s Silicon Valley.

With over 30 years of combined experience in the real estate business and 95% of clients coming from referrals, Mark and Viv take great pride and joy in exceeding their client’s expectations. They achieve this by carefully listening to each client’s unique needs and then creating custom solutions to achieve those goals. Mark and Viv provide clients in San Mateo and Santa Clara Counties with quality and flexible professional real estate assistance.

Know more about Mark and Viv of Vabrato Real Estate

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