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How to Pay ZERO TAXES When Selling Real Estate (Yes, It's Legal!) - YouTube
Channel: Toby Mathis Esq. | Tax & Asset Protection
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- Hey guys!
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Toby Mathis here with
Anderson Business Advisors.
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A question I get quite often is what to do
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when I sell my house to
make sure that I pay no tax,
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and that one's pretty easy.
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There's something called a 121 exclusion
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which most people know
that you have to have lived
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in the house 24 of the previous
60 months prior to selling,
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and you have to pass the ownership test.
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You have to own it when you sell it.
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And so, in English, it means
that if I lived in the house,
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it's one of my primary residences,
or my personal residence,
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and I had 24 months during
that period of time,
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and it qualifies, then I could qualify,
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as a single person, a $250,000
exclusion against the gain,
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the capital gains, not
depreciation recapture,
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that's important, against
the gain on the home.
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Or if I'm married filing
jointly, it's 500,000.
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So that's a big, huge
capital gains exclusion
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that you definitely want to capture.
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Now, here's what sometimes happens.
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Somebody purchases a house,
the real estate market runs up
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over the years, maybe they've
been in it for 15 years,
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20 years, and they want to sell it
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and go move some place else.
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And they say hey, how do I avoid the gain?
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Sometimes they'll have a twist.
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They say what if I want to
keep it, and I want to make it
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into a rental, then do I
just put it into a rental?
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Most of the time, practitioners
are going to say yes,
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and they just left a ton of
money on the counter there
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and they passed up the chance
to use their 121 exclusion.
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Here's why: that 24 of 60 month rule
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applies to before you sell it.
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You have to be the owner, and
you had to have lived in it
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for 24 months out of 60, but, if you were
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renting it too long, you would
lose that deduction entirely.
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In other words, you get
past three years, it's gone.
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So if you're going to keep
it and you're going to
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make it into a rental, it does not
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make sense to not use the 121 exclusion.
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And then you're going to
say, well, you can't use it.
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Who do I sell it to?
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I'm not going to sell it to somebody else.
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How do I get to make it a rental property
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and be selling it to somebody else?
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How do I keep control of that, Toby?
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Well, you have to think outside the box.
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You can sell it to another taxpayer.
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My business partner, Clint
Coons, has done videos on this
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and has done a really
good job of explaining
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how it works and the concept.
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I'm just going to put a little
more meat on the bones here.
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All we're doing is we're
literally taking you.
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So let's say that I have a client,
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as a person, you have a 1040.
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You're the one who gets the 121 exclusion,
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and we're going to sell it
to another taxable entity.
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The most obvious entity
that is going to be the best
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for the tax treatment on a rental property
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is actually going to be an S-Corp.
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And, so, we will make this into an S-Corp.
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And when I say S-Corp, that
means for federal tax purposes,
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so it can be an LLC taxed as
an S-Corp or a traditional
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corporation that makes an S selection.
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And all we're doing is selling it
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at whatever the fair market value is.
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It needs to be fair market
value, something reasonable.
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And, now, you will
capture the 121 exclusion.
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More importantly, so
let's just use numbers.
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Let's say that I bought my house,
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let's just say it's $100,000.
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I bought it for $100,000,
and, now, it's worth $600,000.
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I bought it, let's say
it's me and my wife,
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and we bought it, and we're looking
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at a potential gain of $500,000.
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And you say hey, I don't
really want to sell it,
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but I would like to not pay
tax on that $500,000 ever.
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You do the sale at $600,000.
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The S-Corp agrees to pay you.
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Now, a lot of you guys are
going to say, wait a second,
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where's the S-Corp going to get the money?
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You need to have about
10-20% of the cash to make it
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a bonafide sale, to make
sure it's reasonable.
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So you're going to want to make sure
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that you fund the entity with something,
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but the S-Corp can pay you over time
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under an installment sale.
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In other words, it doesn't have
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to come up with all the cash now.
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Maybe it comes up with $60,000 down.
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What this will do is give you
a new basis here of $600,000.
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If you know how to do depreciation,
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then you're going to take the land value,
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and you're going to subtract
that from this 600,000.
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So 600,000, and you're
going to get X number
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of dollars to depreciate over 27.5 years.
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So what's going to happen is
you're going to get a large
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amount of depreciation as a result.
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You're also going to have
a new basis of $600,000.
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Which means, if in 10
years I decide to sell it
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and it's gone up to 700,000, let's say,
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then my only gain is the 100,000.
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I literally am going to get to keep
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the $500,000 off the
books as far as taxation.
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No tax on that $500,000 of gain
because I chose to do this.
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If I rent it, ordinarily if
it was just me, and I turned
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this into, converted it to a
rental, my basis is $100,000.
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That's what I'm using for
my depreciation, not 100,000
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I have to subtract off of the land value,
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but I would only get to
depreciate a small amount,
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so I lose all that benefit, that means
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that I'd pay tax on all the rents.
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So, in English, I pay a lot more in tax.
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Plus, I just screwed up, and I didn't get
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my $500,000 capital gains exclusion.
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So, let me go over how this works.
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You have to form the S-Corp.
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You have to make sure that
when you're selling it
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that you use an installment sale.
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And, most importantly, you're
using an installment sale,
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but the entity is actually
going to elect out
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of treating it as an installment sale.
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So the entity immediately says I am buying
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this for $600,000, even though
I'm paying it over time,
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I'm treating it as though
I bought it for $600,000.
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All that means for you
is you're recognizing
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all that income, even though you
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haven't been paid the money yet.
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I'm recognizing all of the income
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in the year that I sold it because
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I want to use up that $500,000
big, huge, fat exclusion.
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These are just tax elections
so that the IRS believes
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that I was paid the
$600,000, in other words,
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hey, I know it hasn't paid yet.
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I know it's going to be paying
over time, and it's paying,
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how is it paying me, by the way?
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It's paying with the rent?
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Rent's come in.
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It's paying me on the note, yay!
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You know, I'm going to get the cash.
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Now, the sale has to be a bonafide sale.
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This is a big one.
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It has to be for fair market value.
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So, I'd actually get an appraisal.
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I would literally go
get an appraisal on it,
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and I would probably use
whatever amount is going to
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give me the most bang for my buck.
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I'm going to want to get as
much of that $500,000 as I can.
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So, this number may be different.
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Maybe that's $500,000
that I'm sell it for,
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and I'm only using $400,000 of it.
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I just want to use up my 121 exclusion.
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I don't want to leave it on the table.
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And that 121 is in the
year that I sell it.
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That's me personally; I don't have to
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recognize the gain when I do that.
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And I hope that is starting to sink in
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that we're literally taking something
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that we would have lost
all of that exclusion,
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and that exclusion is worth quite a bit,
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that could be $150,000 worth of exclusion
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depending on where you live,
your capital gains rate,
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plus your state, plus your
net investment income tax.
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All these things start adding up.
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Next thing you know,
you're looking at a 33% tax
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on $500,000, that's over $150,000
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that you gave up of tax
savings, not of deduction of tax
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savings, like dollars you would have paid,
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you quite literally, just by doing
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this you save yourself $150,000.
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Now, one red flag, big red flag.
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Once that property is in that S-Corp,
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if you ever take it out
and give it to yourself,
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that is going to be
treated as ordinary income.
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It's going to be treated just
like the company paid you.
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So you don't want to do that.
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You want to make sure that
you have a good tax advisor
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to keep you from making mistakes,
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but the rents still flow down as rents.
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You have depreciation off-setting them.
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There's a very good
chance you're not going to
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be paying any tax,
depending on the numbers.
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But if you have enough
depreciation, there's a good chance
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you're not going to have much
of a tax bill on the rents
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that you're receiving all those years
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that's coming back into you,
so it's a fantastic situation.
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The only other thing you
should be aware of is you
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may be recognizing some
interest on that note,
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but it's peanuts in comparison
to the amount that you're
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going to capture and you're
going to grab as the exclusion.
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Very, very powerful technique,
often times misunderstood.
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Most practitioners can't
get their mind around it,
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so they immediately say no,
there's no other option.
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There's always an option, and the thing
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you want to get in your head is how.
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Always be asking how can I defer tax?
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How can I avoid paying taxes?
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It's absolutely legal to avoid taxes,
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but the biggest thing is
always starting off with
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is there a way and how do I accomplish it?
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You want to be asking folks
like myself and my group
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and Anderson Business
Advisors and my partners,
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are there ways to get around this?
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And if somebody's immediate
reaction is no, there's no way,
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pass on them and go to the next one
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to see if someone can
actually dig into it.
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There's usually some creative ways
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to push things off into the future
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or capture something
that you are entitled to.
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Like here, this big, huge, fat exclusion.
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We don't want to leave it on the counter.
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We don't want to leave it on
the table for somebody else.
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We just pass it up.
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No, we want to capture that.
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We want to have our cake and eat it too.
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We want to have the step up, so
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that we get higher depreciation.
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And we want to capture our big,
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fat, huge, capital gains exclusion.
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