Burt M. Polson | Napa Valley and Vallejo's Commercial Real Estate Broker

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Retirement, taxes and warm fuzzies - part 1

John and Martha reached a new milestone and are well set in their retirement. They made the right decisions at the right time living comfortably in their large estate home while owning several investment properties.

But, they are ready for a change as their new found focus does not include maintaining a large home or managing several investment properties. 

They are nervous about selling as they created tremendous stability in their lives. They do not wish to forego the stability just to relieve themselves of the day-to-day operations of their properties. Here is how the process went.

John and Martha sell their family home

John and Martha purchased their home over forty years ago for $150,000 and have no mortgage. It is an estate property on several acres valued at over $2M. Over the years they added living space, a pool and other improvements making it a great home for raising children and entertaining. 

Now that John and Martha’s children are long out of the house, they found they just didn’t need so much space in this next phase of their lives together. They decide to sell because the market demand for their home is high. They get an offer for $2.25M.

John and Martha pay lots of taxes

When they purchased their home their costs of the purchase were minimal and even with the significant improvements they made over the years their adjusted tax basis is rather low. 

Their realized gain from the sale is over $1.6M. The IRS allows for an exclusion of the first $500,000 of gain for a married couple leaving them with a net capital gain of just over $1.1M.

John and Martha are in the 33% tax bracket because they invested well, saved for retirement and own investment real estate. Therefore, they owe 15% in federal taxes, 9.3% California and also the 3.8% net investment income tax. The total tax on their $1.1M will be $309,100.

John and Martha could had limited their tax liability

They could reduce their taxes by reducing or redirecting their income thereby lowering their tax bracket. If they can get to below the threshold in income they could reduce their federal capital gains tax to zero percent and the net investment income tax would not kick in. California would still get 9.3% tax.

Other ways to avoid paying capital gains could be to create a charitable remainder trust, offset capital gains with losses or sell using an installment contract where they carry the financing. This essentially spreads their tax liability over many years, but at a higher rate.

John and Martha live happily ever after

John and Martha sold their home and paid the capital gains tax and pocketed almost $1.8M. They decided to purchase a condo for $600,000 still giving them $1.2M to invest.

Please be sure to consult with your tax adviser before selling your home.

In part 2 John and Martha examine the best way to sell their investment real estate.

Burt M. Polson, CCIM, is a real estate broker with ACRES Real Estate Services Inc. helping clients sell, buy and lease real estate. Reach him at 707-254-8000, burt@acresinfo.com or BurtPolson.com.

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