to delay capital gains with installment sale or not

[maisymouser]

The question is whether to do an installment sale / seller financing or normal sale of a rental property to spread out capital gains. My spouse and I, after lots of pre-tax retirement contributions and the standard deduction, have an AGI of approximately 120 or 130K. After raising the basis with a few projects we did, our capital gains on the house will be appx 230-260.   The buyer is making a large downpayment of over half the sale price, and we don’t really NEED the rest of the money now to pay off a mortgage or anything. How much of a benefit would it be to spread the capital gains over five or ten years? Would it affect how our normal work income is taxed? The way I see it, it would be like having a good 6 or 6.5% bond. Would it not be a benefit at all, just delay the pain of the 15% tax? I think that at least we would avoid some NIIT tax of 3.8% on our income over 250k (but that would only be 3.8% of 130 to 150k)?   

   Possible issues that have been pointed out are that the capital gains tax rate of 15% is not set in stone, and we might end up paying more over time if it is raised, and interest from the seller financed loan would be taxable (but same as gains from a bond?).

[SilentC]

I think the interest would almost surely be at your ordinary income but I can double check on Monday.

[secondcor521]

Installment sales spread out the recognition of the gain.  The interest on the loan is ordinary interest in the year received.  See https://www.irs.gov/taxtopics/tc705.

From a tax point of view, it mostly depends on what you expect your tax situation to be over the next five or ten years.  Most of the time it's going to be preferable to spread out the gain; the only situation where it likely would not be is if you expect your income to increase significantly at some point during the installment sales period - for example if you were both going to start SS benefits in two years.

Since it's a rental, you'll have to adjust for depreciation.  I'm not very sure how that works but you can check out IRS Pub 523 where it is discussed.

Yes, NIIT is only on the portion of your income that is investment income (which appears to include the interest you'd get on the installment loan) and is above $250K AGI.  See IRS Form 8960 especially Part III.

Another factor, beyond taxes, is how you feel about being the noteholder.  It creates an ongoing financial connection between you and the buyer.  What will you do if the buyer falls behind on the payments or stops making them?  Are you ready to foreclose?

Whatever capital gain and interest you recognize each year will be included on your tax return along with your work income.  Most people think of their W-2 as their "first" income, so in that sense it wouldn't impact your W-2 income, but it would stack on top of your W-2 income and would therefore be taxed in middle to high brackets.

If I were in your shoes, I would suggest an installment loan term of five years, which would give you a capital gain of ~$50K per year plus the interest received.  Take out your 2022 tax return and add ~$50K of capital gains and maybe $13K of interest (first year of interest at 6% on $250K loan for five years from https://www.calculator.net/amortization-calculator.html?cloanamount=250%2C000&cloanterm=5&cloantermmonth=0&cinterestrate=6&cstartmonth=11&cstartyear=2023&cexma=0&cexmsm=11&cexmsy=2023&cexya=0&cexysm=11&cexysy=2023&cexoa=0&cexosm=11&cexosy=2023&caot=0&xa1=0&xm1=11&xy1=2023&xa2=0&xm2=11&xy2=2023&xa3=0&xm3=11&xy3=2023&xa4=0&xm4=11&xy4=2023&xa5=0&xm5=11&xy5=2023&xa6=0&xm6=11&xy6=2023&xa7=0&xm7=11&xy7=2023&xa8=0&xm8=11&xy8=2023&xa9=0&xm9=11&xy9=2023&xa10=0&xm10=11&xy10=2023&printit=0&x=Calculate#calresult) and see if the resulting increase in taxes is acceptable.

[GilesMM]

Be careful letting the tax tail wag the dog.  If you cash out now, you have the money to do other things with it (despite "not needing it" now).  You could invest it.  This will cost you 15% income tax but it will gain you access to the cash to invest and perhaps earn more than more than fifteen percent on it and end up with a great deal more at the end of the period you would finally receive all the installments.

[secondcor521]

Be careful letting the tax tail wag the dog.  If you cash out now, you have the money to do other things with it (despite "not needing it" now).  You could invest it.  This will cost you 15% income tax but it will gain you access to the cash to invest and perhaps earn more than more than fifteen percent on it and end up with a great deal more at the end of the period you would finally receive all the installments.

Sure.  But if the OP, as part of their AA, wants $250K in a 5 year bond, they can probably get a better interest rate with the installment loan instead of regular bonds or bond funds.  On the other hand, an installment loan is riskier than a Treasury.

[SeattleCPA]

Since it's a rental, you'll have to adjust for depreciation.  I'm not very sure how that works but you can check out IRS Pub 523 where it is discussed.

Fyi installment method doesn't work for depreciation recapture.

[secondcor521]

Since it's a rental, you'll have to adjust for depreciation.  I'm not very sure how that works but you can check out IRS Pub 523 where it is discussed.

Fyi installment method doesn't work for depreciation recapture.

Thank you.  I did not mean to imply that one could recapture depreciation over the installment plan.  Merely that I know that depreciation recapture exists and needs to be accounted for somehow in the process of selling a rental.  Sorry for the lack of clarity.

[SeattleCPA]

Since it's a rental, you'll have to adjust for depreciation.  I'm not very sure how that works but you can check out IRS Pub 523 where it is discussed.

Fyi installment method doesn't work for depreciation recapture.

Thank you.  I did not mean to imply that one could recapture depreciation over the installment plan.  Merely that I know that depreciation recapture exists and needs to be accounted for somehow in the process of selling a rental.  Sorry for the lack of clarity.

Sorry to have sounded so brusque. I was watching the Huskies game and trying to quickly help answer question off my smart phone.

To be clearer, I meant that the part of the gain that's attributable to the accumulated depreciation? @maisymouser will pay taxes on that even in spite of the installment method accounting.

[secondcor521]

Since it's a rental, you'll have to adjust for depreciation.  I'm not very sure how that works but you can check out IRS Pub 523 where it is discussed.

Fyi installment method doesn't work for depreciation recapture.

Thank you.  I did not mean to imply that one could recapture depreciation over the installment plan.  Merely that I know that depreciation recapture exists and needs to be accounted for somehow in the process of selling a rental.  Sorry for the lack of clarity.

Sorry to have sounded so brusque. I was watching the Huskies game and trying to quickly help answer question off my smart phone.

To be clearer, I meant that the part of the gain that's attributable to the accumulated depreciation? @maisymouser will pay taxes on that even in spite of the installment method accounting.

No worries!  I thought that's how it works, but I only know how to deal with simple cases of selling of a personal residence with the full gain exclusion amount (basically, what I learn in AARP Foundation Tax Aide training).  Anything beyond that I refer to a professional like you. ;-)