capital gains on sale of rental properties

What is the name of your state? NJ

I need some good sound tax help. My mom and dad own 2 lots, 1 with a home and one just a lot which they bought 20 years ago for around $25k. These properties are not their primary residence, but their rental properties. They are now worth $900K and I would like them to sell them (they want to too) and enjoy their money without any of their children (including me) benefiting from it. My only concern is the Capital Gains tax. Is there any way they can 1) become liquid without paying this tax, 2) defer it until later so they don't pay or 3) use some other method of borrowing or sheltering themselves while still getting money to enjoy their remaing years (i.e. gifting the money to his brother and using it against their lifetime exemption and getting the money back?) They are both 80 and I think they should have fun, b ut I do NOT want them to shell out 30% of the gains to taxes. Any tax or other advice will be greatly appreciated.

[abezon]

Since they bought 20 years ago, I'll assume the property is nearly completely depreciated & their basis is $0. If the sell, they will have 2 kinds of taxable income: recaptured depreciation & capital gains. The capital gains is everything over the original $25,000 purchase price. Recaptured depreciation is all the depreciation they claimed (or could have claimed) over the last 20 years. I'm guessing it would be around $15-20k. You don't depreciate land, so only the value of the building is depreciable.

Capital gains are taxed at 20%. Recaptured depreciation is taxed at 25%. So their taxes on the sale would be [25% x $20,000] + [20% x $875,000] = $180,000. BUT, the sale of the properties will push their other income up into the 39% tax bracket, so the effective tax on the sale would be higher. They'll also probably have to deal with AMT problems. In other words, they can't sell the property and avoid paying taxes on it.

If the want the cash without a sale, they could see about a home equity loan secured by the property. This would give them cash without increasing their taxable income. An advantage of this scenario is that they could structure their estate planning so that the rental property gets its basis stepped-up to $900,000 on thier deaths. Then you & your siblings inherit the properties with a much higher basis & can sell the property at no profit. This way, no one pays taxes on the sale. (The heirs do have to pay back the equity loan, of course.)

An example: say they take out a loan for $200,000. The rent from the property covers the loan payments & gives them spendable cash. When they pass away, the value of the property is included in their estate ($900,000). Since the first $1.3M is tax-free, their estate pays no federal *estate* taxes on the property. The heirs receive the land with a basis of $900,000. When the heirs sell the land for, say, $950,000, the heirs receive $750,000 cash after paying off the equity loan. The heirs pay *income* taxes on only the $50,000 profit. And they heirs get to pay capital gains tax rates, too. Net tax on the sale = $10,000. There may even be no profit, once the costs of sale (comission, title insurance, etc) are subtracted from the proceeds.

You'll have to ask a NJ estate tax lawyer if this scenario avoids NJ tax laws, too. Also, it may be advisable to put the property into a living trust to avoid probate fees, which many states tie to the value of the probate estate.

All in all, your parents absolutely need to spend a few hundred $$ on a good estate planner if they want to leave the maximum amount of money to their heirs, have cash to spend, and avoid the most taxes.

Thanks. Yes the building is fully depreciated. I will tell them to seek advice. My main concern is that THEY get to enjoy their money, they had enough foresight to invest wisely ($900K for a $24K investment aint bad). I will tell them to seek advice from a REPUTABLE TAX LAWYER. I only have one question.

Is there a place where I can see who is reputable and is there any service offered for senior citizens that they can access??

Thanks again.