Anyone who buys real estate, whether the serious investor or a homeowner who buys an additional house as a long-term investment, must be familiar with the ever-changing and complex tax laws.
A lot of money can be saved or lost if you don't take these tax laws into consideration when you decide to sell or buy real estate.
It is strongly recommended that you see a tax advisor before you sign any documents.
With the rapid inflation that has been taking place in this country, it is assumed that you will make a healthy profit when you sell property. A healthy tax can be the result. One way to ease this tax is an installment sale.
When you sell your principal residence and buy another home of equal or greater value -- within 18 months before or after the sale -- the law permits you to defer (postpone) your profit. But, if you do not meet the requirements for deferral, or if the property you have sold is not your personal residence, a tax will be imposed on the profit you have made.
Under the installment sale concept, the gross profit on a sale is pro-rated over the period in which payments are received. If you have been paid less than 30 percent of the selling price during the year that your property is sold, you may be eligible to have the profit considered under an installment-sale basis.
Why is this important to taxpayers? Because it permits them to include in gross income only that portion of each payment (collection) which constitutes profit.
Suppose, for example, that for tax purposes, your basis in the house is $28,000, and you sell it for $40,000.
The buyer agrees to pay $10,000 down, and $5,000 in each of the next six years, excluding interest on that mortgage. If you do not elect to take the installment sales route, you will have to pay a tax on the entire $12,000 profit. Depending on how long you held this property, the tax would either be on the basis of a long-term capital gain or straight income.
However, if you elect to go the installment sales route, and since you have taken less than 30 percent down in the year of sale, you are permitted to defer the taxes and pay only on the monies that you receive each and every year, and which are attributable to profit -- or in other words a portion of the $5,000.
There are highly complex rules regarding the installment sale. Do not rely merely on a 30 percent computation. The 30 percent must be based on the so-called "selling price" rather than the "total contract price," which is the formula to determine how much tax you will have to pay each year.
For example, you may have an even greater tax savings if, rather than paying off your existing mortgage, your purchaser assumes the existing loan on the property.
It is also important to ascertain whether your many expenses in connection with the sale can be added to the price, and unfortunately the Internal Revenue Service is at odds with the courts on this particular issue.
Next: The tax-free sale and exchange.