Let’s be real: selling a property you’ve held for decades is a big deal. It’s often a milestone that signals a new chapter – retirement, a lifestyle shift, updated investing strategy, or simply stepping back from the daily responsibilities of property management.
But for many long-time owners, the capital gains tax bill waiting on the other side of that sale? It’s enough to make you hit pause.
The good news? There are two savvy strategies that allow sellers to defer (and potentially reduce) capital gains taxes – while still moving forward with a sale. Whether you’re the seller looking for options or the buyer trying to structure a deal creatively, here’s what you should know.
1. Sales Installment Contracts are Seller Financing with a Twist
If the phrase “seller financing” sounds familiar, that’s because it’s often used as a catch-all for a broad range of financing options. But when it comes to tax planning, what we’re really talking about is a sales installment contract.
Here’s how it works:
- The buyer and seller agree to a sale, but instead of paying all at once, the buyer makes payments to the seller (NOT the bank) over time.
- The contract is formalized just like a mortgage and, while a deed is prepared, it’s held in escrow until the buyer pays in full (either through regular payments or by refinancing).
- The seller receives the sale income gradually – usually over several years.
Capital gains are only taxed on what the seller receives each year. So instead of getting hit with a massive tax bill in a single year, the seller spreads out both the income and the tax liability.
Let’s look as a simplified example:
- A seller owns a $1 million property with a $100,000 basis.
- Instead of selling outright, they structure a 10-year installment contract with the buyer.
- Each year, they collect $100,000 – $10,000 of which is their basis (aka not taxed), and $90,000 is subject to capital gains tax.
This could be the difference between being taxed at the 15% capital gains rate versus jumping into the 20% bracket – which kicks in for single taxpayers at $533,000 in annual income.
As a bonus, the seller earns interest on the outstanding balance, which is taxed separately at the interest income rate.
2. Consider a 1031 Exchange into a DST
If a seller wants to fully exit the ownership of the property but still defer capital gains, doing a 1031 exchange into a Delaware Statutory Trust is an option to be considered.
A 1031 exchange lets you swap one investment property for another, deferring taxes on the gain. But when you don’t want to actively manage a new property, a DST allows you to swap properties without management headaches.
Think of a DST like a real estate syndication. The biggest difference between the two is that in a DST, you actually own a portion of the real estate as a tenant in common.
Why does that matter?
DSTs qualify for a 1031 exchange, but syndications do not – because investors own shares in an LLC, not the property itself. With a DST, the seller trades their hands-on investment for a passive role.
Conclusion
Selling a long-held property doesn’t have to mean a gut-punch tax bill.
Whether through a sales installment contract or a 1031 exchange into a DST, sellers can reduce their tax exposure, unlock equity, and enjoy the fruits of their labor on their own terms.
Please note, this post is for informational purposes only and does not constitute tax or legal advice. Please consult with your CPA or legal advisor before implementing any tax strategy.
