Defer Capital Gains Taxes Without a 1031 Starker Exchange

By Bruce Jones | Apr 27, 2016 |

A Case Study in Capital Gains Tax Deferral

Selling an appreciated asset usually triggers a capital gains tax obligation. The timing of that tax payment, however, depends on what happens with the sale proceeds:

  • Those willing to reinvest and buy more property can defer the capital gains tax with a 1031 exchange.
  • Those not willing to keep investing in property (ready to “cash out” in other words), can also defer capital gains taxes for decades, but they need to carefully structure the sale before pulling the trigger to get that deferral.
The first option, the 1031 exchange, is well known and needs no explanation. The second option is not as well known, but is also a very effective method to defer taxes. It is best explained using an example, so let’s step through a recent transaction that uses this tax planning approach.

Selling Property to Retire

A couple had decided to sell a four-unit rental property that they had owned for over 25 years. They were ready to retire from property ownership and wanted to sell the property outright. They announced they were “done with 1031 exchanges and property management.” The sale, though, looked like it might trigger a hefty tax bill; so, naturally, they wanted to explore every legal option to mitigate this tax damage.

They first met with their financial advisor and the tax planner (a colleague of mine.) They gave the planner the information he needed to prepare a tax analysis detailing the full tax exposure if the property was sold.

  • The property was originally purchased for $300,000, and looked to garner a sales price of about $1.25 million.
  • The property also had accumulated depreciation of $162,000 at the time of sale.
  • There was a $398,000 mortgage balance.
The couple thought the tax damage would be about $190k, which was 20% of the net on the sale ($1.250k -$300k). They soon discovered, however, that their tax problem was significantly more than that. They were unaware of other types of taxes that would be sparked by the sale, including the “Net Investment Income Surtax” and taxes due for depreciation recapture and debt-over-basis.


The Details of the Tax Obligations

Here is the Tax Analysis for the Four-Unit Property:

Projected Federal Taxes

Sales Price


Less: Selling Expenses


Net Sale Proceeds


Less: Cost Basis


Taxable Capital Gain


Federal Capital Gains Tax @ 20%


Net Investment Income Surtax @ 3.8%


Accumulated Depreciation


Federal Tax @ 25%


Debt Over Basis

Taxable Mortgage-over-Basis


Federal Income Tax Rate @ 25%


Total Projected Federal Taxes

$ 304,766

Projected California Taxes

Net Sale Proceeds


Less: Adjusted Cost Basis for California


Taxable Income


Plus: Debt-Over-Basis


Total Taxable Income


State Tax Rate @ 12.3%

$ 159,593


$ 464,359

Without a proper tax planning approach, the total taxes due for the sale of this property would have been over $463,000, nearly two and one-half times the amount the couple had expected to pay!

A Different Planning Approach

At this point, the tax planner introduced an alternative: Structuring the sale of the property using a methodology which capital asset sellers can lawfully use to walk away from escrow closing with NO immediate capital gains taxes due and a tax-free lump sum of money that is nearly equivalent to the sale proceeds. This happy result is accomplished by coupling a monetization loan with an installment sale: The Chief Counsel of the Internal Revenue Service stated in a 2012 memorandum that it is permissible for an installment seller to receive loan proceeds at the time of sale—even in conjunction with the sale— and not be taxed on the loan proceeds.

In addition, the sellers eliminated counterparty risk by fully relinquishing any interest in the property. Using this approach to sell the property, the ultimate buyer assumed full ownership with no recourse back to the sellers.

The upshot: The sellers solved their tax problem and received almost $390,000 more money in their pocket tax-free at closing than they would have with a straight asset sale.

They still owe the taxes, but have adjusted the timing of when they pay it to decades in the future. In the meantime, they have invested the proceeds they received at close of escrow to build wealth and generate income. They see the wisdom of using the asset growth they will earn on the deferred taxes to pay those taxes when they finally come due. That is tax efficiency in action!

About the Author…

Bruce Jones entered the financial services industry in 1970 and has taught the subjects of tax management and financial strategy planning since 1974. He is President and CEO of TaxWealth®, a tax analysis and solutions research firm which provides comprehensive income, capital gains and estate tax remedies for owners of real estate, privately-owned businesses and other capital assets.

In addition to serving its own clientele, TaxWealth also supports CPAs, attorneys, financial advisors and real estate and business brokerage professionals in helping to solve their clients’ tax problems.

Headquartered in Newport Beach, California, TaxWealth works with clients and professional Partners nationally. You are encouraged to visit their web site at or call Mr. Jones toll-free at (800) 300-4723 to discuss your tax concerns.