Installment home sale can help ease bite of taxes

Q: We have a rental property that we would like to sell to our son and his wife. The problem is that we have not lived in the house as our primary residence for the required two years and therefore would have to pay a considerable amount in capital gains. Is there any kind of rent-to-buy or reverse mortgage or other arrangement that would make this possible without our facing a large tax bite?

A: Your question seems to mix two concepts when it comes to taxing real-estate sales. If you own a home, use it as your primary residence and have lived in it for two out of the past five years, you can exclude from any taxes up to $500,000 in profit if you are married. That’s the way it would work for personal residences.

If the home isn’t your primary residence and you sell it, you’d have to pay the taxes on the profit. That could be significant, but remember that you’d pay capitalgains tax rates, which would be substantially less than if you were taxed at ordinary rates.

You could sell the home and defer paying federal income taxes if you use a 1031 exchange and buy another. You’d have up to 45 days after your sale to designate a replacement property and up to 180 days to close on the replacement property.

If you want to sell to your son and his wife without buying another property, we suggest doing it on an installment basis. That is, you become their lender and sell the property to them over time. These sales can be complicated, so you’ll need to talk to an accountant.

There are ways to structure installment contracts so that you pay income taxes as you receive the money. You would still pay taxes, but you might pay at a lower rate and over a longer period.