Reference no: EM133039955

Question: 

After learning about real estate taxes, and some options of deferring or sheltering them, how might choose to protect the future investments? Don't forget to support the answer.

Source:

Real estate taxes are ad valorem taxes. Property is reassessed when sold, and property is taxed for the basic levy at a maximum rate of 1% of the fair market value (Proposition 13). The tax rate cannot increase more than 2% per year. Additional special assessments can be added, up to 1% of the fair market value. The homeowner's exemption is $7,000 from the assessed valuation. The exemption for a totally disabled veteran was $134,700 for 2018.

Tax transfers between family members may be exempt from reassessment. For taxpayers older than 55, a sale and repurchase of a principal residence within the same county may allow the taxpayer to keep the old assessed valuation if the new purchase is at the same price as or less than the sales price of the old residence. For residents over 55 years of age, the transfer of assessed value can extend to other counties if the other county has agreed to it (Proposition 90).

For some senior citizens (low income or disabled), a postponement of taxes is possible until the claimant no longer occupies the property.

Capital gains are sale gains on the sale of capital assets. A long-term gain, over 12 months, is currently taxed at a maximum of 15%, except the rate is 20% for high-income taxpayers. There is also a 3.8% Medicare surcharge for high-income taxpayers.

Depreciation is a noncash expense for tax purposes that applies to improvements to income, business, and investment property. It is a return on the investment. Any gain on sale is taxed from the basis adjusted by adding buying expenses and capital improvements to the purchase price, then deducting the accumulated depreciation (adjusted cost basis). For residential property, a 27½-year life is used for depreciation purposes. For nonresidential property, a 39-year life is used.

A taxpayer can defer gains on the sale of business or investment property by use of a 1031 exchange. The property must be like-for-like (real property for real property), and the taxpayer would be taxed only on boot received. Boot is unlike property received, as well as debt relief. A delayed tax-deferred exchange is possible if the taxpayer identifies the property within 45 days of a transfer and closes escrow within 180 days of the transfer.

Installment sales allow a taxpayer to spread a gain over the years in which the gain is received. This could mean a lower tax rate.

A sale-leaseback allows a seller to gain operating capital, reduce debt, and have the 100% tax deduction of business rent.

Residential property owners have a tax advantage for interest payments on $750,000 in acquisition indebtedness (for primary and secondary residences), as well as up to $100,000 in equity indebtedness if used for purchase or improvements.

A homeowner's gain on the sale of a residence is determined by deducting the adjusted cost basis (cost plus improvements) and the selling expenses from the selling price. The Taxpayer Relief Act of 1997 made some significant changes to tax law regarding gains on the sale of real estate. These changes include a once-every-two-year exclusion from taxation for gains on the sale of a principal residence that has been occupied by the sellers for at least two years during the prior five-year period. This exclusion from taxation is as follows:

• Married couples, $500,000
• Single persons, $250,000

When a property is sold by a foreign national, it is the buyer's responsibility to withhold 15% of the price for federal income taxes and 5% for state income taxes, unless the transaction is exempt from such withholding. The state withholding applies to all nonresidents of California.

Depreciation is a paper expense that can be used to shelter up to $25,000 in active income from taxation (The maximum amount is reduced by $1 for every $2 in income over $100,000).

Death results in a stepped-up cost basis that is based on value at the time of the decedent's death. There is a federal estate tax but no California estate tax. By using a living trust, a couple can double the amount of their estate tax exemption.