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Can taxes on installment sale income be mitigated?

January 16, 2004


Subject:  Question!
Date:  Thu, 1 May 2003
From:  Nick

Just wanted to ask a real estate question. My client was holding a note on a property that he owned and self financed directly with the borrower. With the very low interest rates, the borrower decided to pay off the loan he was paying 8.5% on. My client is now burdened with a tax bill on the $500,000 balance that was owed to him on the original note. He is faced with reinvestment risk (finding a similar 8.5% return) and a TAX BILL for 2003. Is there anything he can do to delay paying the tax bill for 2003 or reinvest that money in another property to prevent the tax burden altogether?

Thank you,
Nick

Answer

Date:  Wed, 7 Jan 2004

Hello Nick,

Probably not. If the property was a principal residence, the residential gain exclusion could apply. Otherwise, an early payment of the installment sale results in the balance of the gain being taxable. Does your client have any investments with built-in losses that can be sold to offset against the gain? That is a possibility.

Also, if the gain was a long-term capital gain from collections after May 5, 2003, it may be taxable at the new 15% maximum tax rate for long-term capital gains.

It's not necessarily a bad thing to get your cash in hand from an installment sale, even when you have to pay some tax. The risk of loss has been dramatically reduced.

In the future, your client should consider including a prepayment penalty in installment sale contracts. He should consult with a real estate attorney to find out what state laws apply to prepayment penalties in this situation.

Good luck!
Mike Gray

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IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this website was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Can taxes on installment sale income be mitigated?

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