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Many people hold significant portions of their wealth in real estate. However, when they sell property for reinvestment or to fund their retirement, they can lose a portion of that wealth to capital gains taxes. Knowing how to defer capital gains tax on real estate can help you preserve your wealth and maximize its continued growth.
Why Would a Property Owner Want to Defer Capital Gains Tax?
When you sell real estate or an investment property, you must pay taxes on the capital gain you earn from selling the property. This term refers to the difference between your basis in the property — usually, the price you paid for the property or the property’s value when you acquired or inherited it — and the price for which you sell it. The Internal Revenue Service (IRS) imposes a 0, 15, or 20 percent long-term capital gains tax rate, depending on the taxpayer’s taxable income. Most people fall within the 15 percent bracket, although high-income earners may be taxed at a rate of 20 percent (or higher in certain circumstances).
When an owner sells a capital asset, such as real estate, they can lose a significant percentage of the growth in value they gained from the sale. Thus, a property owner may want to investigate options for tax deferral on a property sale to meet wealth preservation goals and prepare for a secure financial future.
Can a Trust Be Used to Postpone Real Estate Taxes?
Yes. A properly structured trust (453 Trust, Deferred Sales Trust, Structured Installment Trust, Charitable Remainder Trust) allows a real estate owner to spread capital gains tax liability that would typically be due after a property sale over multiple years. When the owner transfers their real estate to this type of trust, they receive an installment contract outlining how the trust will distribute the sale proceeds to them. The owner incurs no capital gains tax when the trust sells the property to the ultimate buyer. Instead, they pay tax only on the portion of the sale proceeds they receive in a given tax year.
Benefits of Using a 453 Trust for a Real Estate Sale
Using a 453 trust to facilitate a real estate sale can provide a property owner with various potential benefits, including:
- Avoiding capital gains tax liability, with taxes due only when the owner receives distributions from the trust
- Ability to reinvest the sale proceeds to continue accumulating wealth
- Flexibility in the timing of receipt of sales proceeds
Risks of Deferring Capital Gains on Real Estate Sales
Potential risks of using a deferred sales trust for a real estate sale include:
- Improper structuring of the trust, which can trigger immediate capital gains tax liability, invalidate the deferral strategy, and expose the taxpayer to fines, penalties, and interest.
- Maintaining ongoing control by the seller over trust assets or investment decisions can create “constructive receipt” issues in the eyes of the IRS and destroy the tax-deferral benefits. Ensuring proper independence of the trustee and maintaining arm’s-length governance is critical.
- A lack of direct IRS guidance on the use of these specific trust structures for installment sale deferral. While the 453 Trust strategy relies on longstanding installment-sale rules and robust governance, these types of trusts have not been explicitly blessed by the IRS, creating potential audit risk.
- Loss of access to the sale proceeds upfront, since deferring capital gains taxes through a trust requires receiving payments over time rather than receiving a lump sum at closing.
- Ongoing administrative, trustee, and accounting compliance costs for maintaining the trust
Ready to Learn More About Deferring Taxes on Your Real Estate Sale? Start Today
If you’re interested in minimizing taxes on property sales, an installment sale trust could be The Tax Tool You Didn’t Know You Had. Talk to the team at 453 Trust Powered by Pennington Law. Our deferred sales trust attorneys can advise on potential strategies to make the most of your real estate sale. Contact us today for a free consultation.
