Disclaimer: Information contained
below was accurate as of the date of publication. Due to frequent tax law changes, information may no longer be accurate.
For the latest tax information, please contact a member CPA.
HOW TO AVOID PAYING TAXES WHEN
SELLING REAL ESTATE
Andrew D. Schwartz, CPA
If you're fortunate enough to own
real estate, you're probably sitting on a substantial amount of
appreciation. What happens when you sell your real estate?
How much will you end up paying in taxes on the gains you
If you're selling your principal
residence, the rules are quite liberal. You won't pay any
taxes on the first $250,000 of gain if you're single or $500,000 of
gain if you're married, as long as certain conditions are met.
When selling rental or business
property, however, you're not so lucky. In fact, the taxes
you owe could be substantial. Not only will you be taxed on
the property’s appreciation, you'll also be taxed on the
depreciation you claimed over the years. Let's say
that you purchased a building for $390,000 that you owned for 10
years, and can now sell for $780,000. Assuming
you claimed depreciation of $100,000 over the years, you'll owe taxes on a
gain of $490,000 ($780,000 - $390,000) + $100,000).
Fortunately, by structuring the sale of your real estate as a
“deferred exchange”, you can avoid paying taxes on the gains your
realize. Also known as a "like-kind exchange" or a "1031
exchange", this tax saving opportunity is available only in
connection with the sale of investment and business assets.
Vacations homes and other personal-use property don’t qualify.
With a deferred exchange, you'll only pay taxes on the portion of the sales proceeds that
either isn't reinvested into a new property or is used to decrease your
outstanding mortgage debt. By choosing replacement
property that is more expensive than the property you’re selling, you'll
generally avoid paying any taxes whatsoever.
The rules for a deferred
exchange are quite specific and must be followed very closely for this tax
savings strategy to be successful. Here are the basics:
You must use a qualified intermediary, such as an escrow agent or a title
company, to facilitate an exchange. Once you take possession of
any money in connection with the sale of the property, you'll be taxed on
that amount. The easiest way to find a
qualified intermediary is to search the web, but make sure to check them out
very carefully before sending them any money or transferring your property
You must name three possible replacement
properties within forty-five days of relinquishing your property to the
qualified intermediary. For the property to qualify,
you must replace real property with real property and personal property with
personal property. Replacing a two family house with an apartment building, an office building, or even undeveloped land is
okay with the IRS.
You must take title of the replacement
property within 180 days of
relinquishing your property to the intermediary.
With this step, you need to keep an eye on the calendar. If April 15th
falls before the 180-day period has elapsed, make sure to file for an
extension of time to file your 1040, unless you will have purchased the replacement property by that date.
While deferred exchanges can be quite complex
transactions, taking advantage of this tax savings opportunity could save
you thousands of dollars of taxes. If you plan on selling real
estate that you own, make sure to learn more about deferred exchanges
before placing that property on the market.
THE NEW ROTH 401(k) AND 403(b)
Andrew D. Schwartz, CPA
If you like tough decisions, you'll love the new Roth
401(k) or 403(b). Your employer can begin to offer you this twist to these
already popular retirement savings plans on January 1, 2006.
Employers who offer 401k or 403b plans aren't required
to provide their staff access to a Roth version of their plans, so now's the
time to ask your employer's benefits department whether they have
started the process of amending their plan documents. Don't be
surprised if your employer balks, however, since Roth 401k's are scheduled
to sunset on December 31, 2010 - meaning you'll have only five years to
contribute to this type account unless a future tax bill extends their shelf
Wondering what's the difference between your
traditional salary deferral plan and its Roth counterpart? While
contributions made to your current 401k or 403b plan reduce your taxable
earnings, you'll be taxed on money withdrawn from these retirement savings
accounts down the road.
With a Roth account, you forego a tax savings today,
but the money invested within the account grows tax-free - provided you're
at least 59 1/2 and the account has been open for at least five years before
any money is withdrawn. Let's say your Roth 401k account is worth
$50,000 when your retire. You can withdraw the full $50,000 from that account
and not pay a dime in income taxes.
In the old days, tax planning was easy. "Do what
you can to save taxes today" was the motto of the times. And the
government, by having a habit of tinkering with the tax rules, gives
credence to this motto. Keep in mind that these Roth accounts contradict this philosophy since they force
you to forgo a tax savings today.
If your employer provides you with the opportunity to
contribute to a Roth 401k or 403b account, what should you do? If you
trust the government not to substantially change the Roth rules between now
and when you retire, consider going with the Roth if:
You're relatively young and plan to keep the money
invested for a long time.
You're in a low tax bracket today, or feel that tax
rates will be higher in the future.
You've always wanted to contribute to a Roth IRA, but your
income has consistently been too high for you to put money into one.
You want your heirs to keep as much of the money they
inherit from you as possible, since they won't owe income taxes on
distributions received from Roth accounts. (However, the amount they
inherit from you might be less since you've paid higher taxes in years you
contributed to a Roth 401k.)
You don't rely on the tax savings realized on your
current contributions to your 401k or 403b account to meet your household
For 2006, you can elect to contribute a total of
$15,000 into a 401k or 403b account through salary deferrals. Anyone
50 or older by the end of the year can contribute an extra $5,000. If
your employer offers a Roth, you'll allocate your salary deferral between
your Roth and non-Roth accounts. Even so, any matching contributions
made by your employer go into a non-Roth account.
Amounts contributed to a Roth account at work don't
limit the amount you can contribute into your own Roth IRA. For 2006, you
and your spouse can each contribute up to $4,000 ($5,000 if 50 or older)
into a Roth IRA. Eligibility phases out for single individuals earning
between $95,000 and $110,000 and for married couples earning between
$150,000 and $160,000.
Here are a few other rules about Roth 401k's.
Contributions made into a Roth account must be segregated from your non-Roth
money. Elections to contribute to a Roth are irrevocable, and money
can't be transferred between Roth and non-Roth accounts. If you change
jobs, you'll roll the money from your Roth account into your new employer's
Roth 401k, or into a Roth IRA.
Don't worry too much about this decision. As long as you take full
advantage of the 401k or 403b plan provided by your employer, you've already
made the right choice.
Tax and Financial Planning Calendar for October, 2005
Saving and Investing
2004 & 2005 Tax Facts
- For 2004 the standard deduction for a single individual is $4,850 and for a married couple is $9,700. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
- For 2004, the personal exemption is $3,100. Individuals will claim a personal deduction for themselves, their spouse, and their dependents.
- The maximum earnings subject to social security taxes is $90,000 for 2005 up from $87,900 in 2004.
- The standard mileage rate is $.485 per business mile as of
September 1, 2005 (after being $.405 per mile through August 31, 2005), up from $.375 per mile for 2004. .
- The maximum annual contribution into a 401(k) plan or a 403(b) plan is $14,000 for 2005. And if you'll be 50 or older by December 31, 2005, you can contribute an extra $4,000 into your 401(k) or 403(b) account this year.
- The maximum annual contribution to your IRA is $4,000 for 2005. And once you turn 50, you can contribute an extra $500 into your IRA this year. You have until April 15, 2006 to make your 2005 IRA contributions.
copyright - 2005 - CPANiche, LLC