If you hold substantially appreciated assets, selling those assets can result in a hefty tax bill. Turning over a sizable proportion of the profits from the sale significantly reduces the benefits you gain from making a sound investment decision. However, you don’t necessarily need to take such a hit, at least not upfront.
It is possible to your defer capital gains tax. The right deferral strategies can help you control when you pay capital gains taxes and how much. You can further grow your wealth and you may even be able to reduce your capital gains taxes in the long run.
What Is a Capital Gains Tax?
The federal government considers nearly everything you own as a capital asset, meaning you can sell them for cash. If you sell an asset for more than its value when you purchase it, you make a profit, and the Internal Revenue Service counts this profit as additional income. However, some assets appreciate considerably, resulting in a substantial sum of money.
While buying and selling highly appreciated assets is an excellent wealth-building strategy, capital gains taxes reduce how much you walk away from a sale with, which can impact your current and future financial security. The IRS requires you to report the income you receive from selling your assets. Selling at a profit results in a capital gain, but how long you hold the asset matters.
Short-Term vs. Long-Term Capital Gains
The government classifies capital gains according to the length of time you had the asset in your possession before selling it. In most cases, holding an asset for a year or less leads to a short-term capital gain, while selling after a year is a long-term capital gain. The IRS taxes these two categories differently.
Short-term capital gains are subjected to a standard, graduated income tax rate. Long-term capital gains are taxed based on how much they impact your overall income. Your capital gains taxes could be between 0% and 28%, depending on your income. While most pay a 15% rate, selling collectibles or qualifying small business stock results in a 28% capital gains tax.
How Can You Defer Capital Gains Taxes?
If your taxable income is less than $41,675 for single filers or $83,350 for joint filers (in 2023), you won’t have to worry about deferring capital gains tax. However, if your taxable income exceeds these thresholds, you might consider implementing a deferral strategy. Your options depend on the type of asset you wish to sell. If you hold real estate, you have a little more flexibility than other holdings. However, a deferred sales trust is an option for any asset.
Real Estate Options
If you have a real estate investment that you wish to sell, you have two options that are not available with other asset classes: 1031 exchanges and qualified opportunity zone investments.
1031 Exchange
A 1031 exchange allows you to defer capital gains taxes when you purchase another property of the same kind. These like-kind “exchanges” must adhere to the following criteria:
- You must identify a qualifying property within 45 days of selling your current property.
- You must take possession of the qualifying property within 180 days of selling your existing property.
- You must use a qualified intermediary to conduct the exchange. You cannot handle it yourself.
Though the 1031 exchange allows you to put off paying capital gains taxes, you will have to pay in total if you eventually sell the new property.
Qualified Opportunity Zone Investment
A QOZ investment allows you to use your profits from selling your current property to purchase another property in a qualifying economically distressed community. Not every economically distressed neighborhood carries a QOZ label. As with 1031 Exchange sales, you must meet specific criteria to defer capital gains taxes:
- You must complete the new property purchase within 180 days of selling your current property.
- The property exchange must be for equity interest rather than debt interest.
- You must transfer the funds from the sale to the investment through a qualified opportunity fund.
Furthermore, the IRS adjusts the tax benefit based on how long you’ve held your current property before you sell it. The longer you own the property, the greater your tax benefit.
Using the QOZ strategy does not allow you to defer capital gains taxes indefinitely. You can only put off paying your taxes through the end of 2026. If you sell the new investment property sooner, you will owe capital gains taxes for the year you conduct the sale unless you utilize another capital gains deferment strategy.
An Alternative Option
Regardless of the asset class you wish to sell, a deferred sales trust allows you to defer paying your capital gains taxes. It also can prevent you from having to pay the entire tax upfront. You can use a DST even if you already have a 1031 exchange and are looking for a way out.
A Reef Point DST is a secure installment sale form and a valid strategy for deferring capital gains taxes. A DST is a legally binding contract between you and a third party. You must use a DST trustee; thus, you cannot appoint yourself.
Before selling your current property, transfer it into the deferred sales trust. Once the sale is complete, the profits transfer directly into the trust. You receive installment payments from the trust and only pay capital gains taxes on installments you receive in any given tax year. You and the trustee establish how much you receive each month and when the pay will begin.
Who Can Help You Defer Capital Gains Taxes With a DST?
Reef Point’s sole purpose is to help people like you. We specialize in deferred sales trusts and know how to use them to defer capital gains taxes while growing your wealth and providing an additional income stream. If you’re interested in finding out whether a deferred sales trust is suitable for you, get in touch with our office today.
Sources:
https://www.irs.gov/taxtopics/tc409
https://www.irs.gov/credits-deductions/businesses/opportunity-zones