First, a brief primer. Capital gains result from the sale, or deemed sale, of a capital asset (like real estate). The gain is measured on the difference between the “basis” of the capital asset and the sales price or fair market value at the time of the triggering event. While we cannot fully describe here how “basis” is calculated, it usually starts with the purchase price or acquisition cost of the capital asset and any required adjustments.
A capital gains tax is imposed against the gain incurred upon the sale or triggering event. Currently, the capital gains tax rate is generally one of 0% (see below), 15% or 20%, again subject to certain adjustments.
In addition to the Opportunity Zones, these other strategies are available to either defer or avoid capital gains. Each of these have their proper place and use, and can be useful in the proper circumstances.
- SALE OF RESIDENCE. Most people involved with the sale of the residence are aware of the capital gain exclusion of either $250,000 (single person) or $500,000 (married persons) from the gain on the sale. Essentially, if a married couple purchases their residence for $300,000 and sells it for $500,000, no capital gains tax would typically be due. Specific rules apply to basis adjustments and qualification and timing of the use of the property as a residence, among other things.
- DEATH. This is not typically considered a “strategy”, but the IRS allows for a “step up” in basis to fair market value at the time of an owner’s death. What this means for beneficiaries is that at the time of their inheritance, they will receive the capital asset with an adjusted basis of the date of death fair market value. When they sell that asset, the capital gain will be the difference between the date of death fair market value and the sales price. Therefore, all of the accumulated gain while the asset was in the hands of the decedent is not taxed.
- LOW INCOME TAXPAYER. Certain low-income taxpayers, whether by circumstance or whether through planning, can qualify for a 0% tax rate on long-term capital gains. As a strategy, some taxpayers are able to control their taxable income in certain years so that their tax bracket is below the required 15% marginal income tax bracket to qualify for the 0% capital gains tax rate.
- SECTION 1031 LIKE KIND EXCHANGE. This strategy refers to an IRS code section which allows a seller to defer capital gains from the sale of an asset if the proceeds are reinvested in a subsequent “like kind” asset. This strategy is fairly typical in the real estate world, but it does have certain specific requirements and intricacies to make it work. However, please note that this only defers capital gains tax, and the tax is not eliminated unless there is a different strategy used with it such as death or capital gain exclusion on the sale of a residence.
- CHARITABLE CONTRIBUTION. This can also be a complicated strategy depending on IRS code sections, but the fundamental concept is that by contributing high gain (highly appreciated) property to a qualified charity, the donor will get a deduction based on fair market (appraised) value of the property, and the charity can sell the asset usually without incurring liability for a capital gains tax.
- SALE TO TRUST. An even further complicated estate planning strategy involves the “sale” of appreciated property to a certain type of trust (sometimes called an “Intentionally Defective Grantor Trust” or “IDGT”) which will not trigger a capital gains taxable event. There are very strict requirements for the trust and the structure of the sale, but this can be useful for income producing properties in particular.
It is important to note that because these strategies involve tax code provisions, and for each you can expect nuances, subtle distinctions, loopholes, special rules, incorrect interpretations and unqualified opinions when it comes to their application. Further, what may work for a US citizen may not be available to a foreign owner. Make sure that you rely on qualified and competent tax, real estate and estate planning professionals before utilizing any of the strategies