Because Lori's building lot is investment property, any gain she realizes from its sale will be treated as a long-term capital gain since she has owned the property for more than one year. The capital gains tax on the sale of this property, under current tax rates, will be 15 percent. That amounts to a tax bill of $30,000 ($200,000 gain times 15 percent capital gains tax rate = $30,000).
She could defer a portion of the gain by selling the property on an installment basis, using seller financing. However, the current maximum rate of 15 percent on capital gains may not apply in future years. Therefore future payments from the installment sale may be subjected to a higher tax rate.
Consider a like-kind exchange
Another possibility, which would defer all the capital gains tax on the sale, would be to exchange the investment property for other investment property in a like-kind exchange.
Like-kind exchanges are covered under Section 1031 of the Internal Revenue Code. Simply stated, no gain is recognized on the exchange of property held for investment purposes if the property received in exchange is also held for investment purposes. This rule does not apply to certain types of property, such as inventory, stocks, bonds, notes and other intangible investments.
While the rules under Section 1031 are somewhat complex and beyond the scope of this article, the ability to defer taxes and thus invest the full value of the property in another investment property, including income producing property, is an attractive alternative. There are reputable companies that specialize in putting together investors with properties for like-kind exchanges. In Lori's case, deferring taxes of approximately $30,000 could be a very attractive alternative.
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