Reduce taxes with an installment sale
If you own an investment property or a small business, you may want to sell it someday.
One of the reasons that prevent people from selling their business or investment property is the huge tax liability that making the sale can create. The profit is likely to be subject to the capital gains tax.
Turning the sale into a seller-financed installment sale could save you a substantial amount of money. Deferring taxes to later years can cut your tax bill by spreading your profits over multiple years. This enables you to pay the tax in a lower tax bracket each year rather than pay the tax in a high tax bracket the first year.
If your income is relatively low the capital gains tax rate is 0%, enabling you to pay no tax on the gain. The capital gains rates are zero, 15, and 20 percent.
In 2023, your capital gains rate is zero if your taxable income is less than or equal to $41,675 for single people, and $89,250 when filing married filing jointly. Your taxable income is the amount of your income after taking the standard deduction or itemizing.
An installment sale is a sale of eligible property where you receive at least one payment after the close of the taxable year in which the sale occurs.
For example, suppose a married couple’s income is $60,000, and sold a property and had a gain of $100,000 in 2022. Their tax on the gain would be $7,875. By selling the property over 10 years, they would have a gain of $10,000 each tax year. In this example, there would be no tax on the $10,000 gain in 2022. If their income remained about the same in the future years of gain, they would likely pay no tax on the gain of the property. This strategy would provide substantial tax savings and allow them to earn additional income each year from the interest they would receive.
An installment sale offers several advantages for you as a seller, as well as for your buyer:
- You can negotiate the sale without the need for the buyer to pay the full sale price when you finalize the sale.
- You can finalize the sale agreement without waiting for the buyer to qualify with a lender.
- You and the buyer can modify the terms of the sale to meet your needs without getting approval from a third-party lender.
- You can defer taxes on your gain and potentially reduce or pay no taxes.
It’s essential to document the buyer’s obligation to make future payments to you, with a deed of trust, note, land contract, mortgage, or other evidence of the buyer’s debt to you. You should also secure the debt.
An installment sale can enable you to reduce your taxes while also earning additional interest income.
David Zubler is a tax accountant and Enrolled Agent in East Tennessee, providing tax strategies and representing clients before the IRS and has over 25 years of tax experience. He is the author of six tax books and has shared tax advice on national TV. He is the founder and president of Your Tax Care. The company provides business and tax education, including David’s one-minute tax tip radio recordings at YourTaxCare.com. David can be reached at (865) 363-3019 or contacted by email at firstname.lastname@example.org.