Advice for home owners • February 1, 2023

SPECIAL REPORT: Step-Up in Basis ~ What It Is & How Does It Apply to Real Estate

by Scot Campbell

By Scot Campbell, Broker | Coldwell Banker-Campbell Realtors | Scot@CampbellRealtors.com | 714-336-0394

According to an informative article written by Kimberlee Leanard in Seeking Alpha, a “step-up in basis” is an adjustment to the value of appreciated assets upon inheritance.

It is important to understand the rationale for this rule and how it impacts investment real estate and personal residences. Here are some notes and examples I made when reading her article and others which provided useful information:

What Is the Step-Up in Basis?

Investment real estate and personal residences can appreciate massively before they pass to heirs. It is not uncommon for a personal residence owned for 20 years in coastal areas of California to appreciate $500,000, $1,000,000, $2,000,000 or more.

When someone inherits real estate and later sells it, the IRS allows the date of inheritance to establish the cost basis rather than the date of purchase by the person it was inherited from. This allowance by the IRS is called “Step-Up Basis”.

The “step-up in basis” is part of the IRS inheritance tax rules that allow the person inheriting an asset to use the fair market value of the asset at the time of inheritance as the cost basis for taxes when selling the asset. It is designed to reduce the capital gains tax for heirs on inherited assets.

Note: It’s important to understand that a step-up in basis only happens after a benefactor dies—taxes on assets transferred before death are subject to the original cost basis.

Purpose of the Step-Up In Basis

The rationale behind this rule is that property may have been held for many years, if not decades, with considerable gains. Taxing the asset based on the original purchase price can seem unfair and, in some cases, cannot easily be determined if the original purchase records exist.

For example, an Orange County, CA home purchased in 1950 may have only cost $10,000 at the time. If this home transfers ownership upon the owner’s death in 2022, and is valued at that time at $950,000, the beneficiary could be responsible for a $940,000 taxable capital gain if they were to sell the property at that time.

By using the IRS inheritance tax rules, “step-up in basis”, the beneficiary’s adjusted cost basis becomes the $950,000 (appraised) value of the home at the time of death and they do not inherit the huge unrealized capital gain liability for the prior 71 years.

How Step-Up Basis Is Calculated

The step-up in basis is calculated based on the date of death. This calculation is relatively simple; a snapshot is taken of the fair market value on the date of death. For investment real estate or personal residences, a fair market value appraisal is used to determine value on the date of death.

Step-Up In Basis Examples

Let’s look at an example to determine how the step-up in basis works.

Example #1:

Bill & Sue are a married couple. They purchased their personal residence in 1970 for $25,000 in Southern California, a community property state.

The couple created a revocable living trust in 2000, placing all of their assets in it. Bill died in 2022. At the time of his death, the personal residence was free of loans and valued at $1,525,000. This is the new cost basis for Sue on the personal residence which is now owned by her alone.

Sue can afford to stay in the home because the house is free of loans and the property taxes remain very low thanks to Proposition 13. So, she elects to spend the rest of 2022 living in the home and celebrate one more holiday season at her personal residence.

In early 2023, Sue decided to go live closer to her daughter and grandchildren, so she sold the property for $1,600,000 netting $1,520,000 after closing costs and a few repairs. Since the “step-up basis” is more than her net proceeds, there is no capital gain tax on the $1,520,000 proceeds from the escrow.

Sue buys a townhouse near her daughter for $520,000 and puts $1,000,000 into a safe investment which pays her $4,000 per month to supplement her other retirement income. She can afford to travel with her daughter and friends when the opportunities arise, and she lives very comfortably.

Example #2:

Robert & Darlene are a married couple. They have a son named Robert Jr. and daughter named Jane. Robert & Darlene purchased their personal residence in 1980 for $50,000 in Southern California, a community property state.

The couple created a revocable living trust in 2000, placing all of their assets in it. Robert died in early 2022 followed a few months later by Darlene. At the time of her death, the personal residence had a loan balance of $500,000 and valued at $1,900,000. This is the new cost basis for Robert Jr. and Jane who inherited the property 50% each upon the death of their father and mother.

Both Robert Jr. and Jane live outside of Southern California. Neither of them wants to live in the old family home (and buy the other out).

Due to Proposition 19, which was enacted in 2021, the property taxes will increase to approximately $21,000 since neither Robert Jr. or Jane are able to move into the property and claim an exemption.

Living outside the area, neither Robert Jr. nor Jane can effectively manage the old family home as a rental. The increase in property taxes to $1,750 per month, mortgage payments, insurance, maintenance, plus the cost of a property manager makes the cash flows from renting the property unattractive.

In early 2023 when Robert Jr. & Jane learn IRS inheritance tax rule “step-up basis” allows them to receive the proceeds from the sale of the house “tax free”, they decide to sell the property for $1,900,000. They net $1,800,000 after deducting accumulated interest, closing costs and a few repairs. The “step-up basis” is more than their net proceeds, so there is no capital gain tax on the proceeds from the escrow after paying off the $500,000 loan. The net after paying off the loan for the property is $1,300,000, so each gets a wire transfer of approximately $650,000 at close of escrow.

Robert Jr. uses the proceeds to pay off his mortgage and takes early retirement. Jane uses her funds to pay for college for her two children, and the remainder goes into investments to fund her future retirement.

Bottom Line

The step-up in basis is a valuable way for beneficiaries to preserve their inheritance. It allows them to use the present-day market value of assets rather than original purchase prices, often saving considerable amounts in capital gains taxes when assets are ultimately sold.

Here is the original article from Kimberlee Leanard, information on Proposition 19, and other articles on the subject:

https://seekingalpha.com/article/4458768-step-up-in-basis#what-is-the-step-up-in-basis

https://www.boe.ca.gov/prop19/

https://www.naimishlewislaw.com/estate-planning/proposition-19-property-tax-changes-and-inheritance/

https://www.quickenloans.com/learn/step-up-in-basis

Seek Tax Advice Before Transacting

The information contained herein is intended to provide general information and is not intended as a substitute for individual legal advice. Specific examples used are only general examples, and the actual amount of capital gains and property taxes owed for any person will depend on the specific situation of the individual and a wide variety of other factors. Therefore, all persons are directed to seek the advice of an attorney regarding their specific tax and legal situation.

Advice for home owners • January 25, 2023

SPECIAL REPORT: Residential Installment Sales ~ Who should consider this type of a home sale?

by Scot Campbell

INSTALLMENT SALES ARE FOR HOMESELLERS WHO WANT TO REDUCE CAPTIAL GAINS TAXES AND DESIRE RELIABLE MONTHLY INCOME AFTER THE CLOSE:

For years, sellers of real estate have used Installment Sales (seller carry back financing) to reliably collect income after selling a property… they also did it to defer and minimize capital gains taxes.

When rates were very low last year, buyers had no interest in seller carry financing (because most carry back sellers expect to be paid off in 5 or 10 years… buyers prefer not to have a balloon payment), and sellers certainly were not excited about a 2.75 to 3.00% interest rate (market mortgage rates back in early 2022).

But now, with a qualified buyer, sizable down payment and/or Blanket Encumbrance, sellers who carry back financing can get an excellent after-tax return & reduce risk to a level well below other investments.

Research shows approximately 42% of the potential move-up buyers are sitting with lots of equity and an existing mortgage between 3% & 4%… these are buyers who would pay top dollar for your property if they could get an interest rate close to what they have now.

I am already seeing property owners benefiting from the Market Shift by doing Installment Sales. Once again, there is an abundance of qualified buyers with strong down payments and the ability to make reliable mortgage payments… And, this is exactly what some property sellers want because a standard sale with all profits realized in the year of sale could trigger a very large capital gains tax bill (as much as 38%, perhaps more if the property is highly appreciated and seller has a very high annual ordinary income to begin with).

Another consideration sellers like: By accepting interest only payments, the capital gains tax can be deferred until the principle is paid off… So, sellers collect interest (for years) on money that would have been paid to the IRS.

A Success Story for Today’s Market

SOLD for $1,550,000 with Seller Financing

3.95% Interest Rate | 15-Year Amortization

48% Down | Balloon Payment End of Year 5

Attached Home | 3 BR | 2.5 BA | 2266 SqFt | Built 1980

Problem: The seller of this Downtown Huntington Beach rental property owned it for over 30 years and was no longer interested in being a landlord. The basis was extremely low, so a standard sale with proceeds received at closing would have resulted in a very big capital gain tax liability. However, he did not know a safer place to invest (secure) the funds than the property itself.

Solution: The seller sold the property using an installment sale. With a $750,000 down payment received from the buyer. The seller was able to pay off the existing mortgage and capital gains taxes due, plus he put cash in the bank for a rainy day. The principal & interest payments received over the next five years spreads out the taxable gain, which offers a nice income to supplement retirement and lowers the tax rate on the funds. Until the loan is paid off, the seller earns interest on money which would have been paid in taxes at year one… this effectively boosts the seller’s yield well above the interest rate being paid by banks.

Safe & Secure: What investment is more comfortable than holding a mortgage on a house in Huntington Beach with 48% down payment, highly qualified buyer, and fully documented loan which meets government standards?

Is an Installment Sale something you should consider?

If you are a homeowner with a highly appreciated personal residence (well above the $250,000 per spouse IRS section121 limit), or if you are a long term “Worn-Out Landlord”, an Installment Sale might be an interesting option to consider.

The capital gains tax liability due on the sale of the property will likely be reduced, and you can begin earning “hassle free” interest on your equity. Use the proceeds & income to travel, purchase an RV, buy/rent a more suitable residence, move closer to friends/family, or even help your kids or grandkids with college.

Questions?

SCOT CAMPBELL | Global Luxury Specialist | COLDWELL BANKER-Campbell Realtors

714.336.0394 Mobile / Scot@CampbellRealtors.com / www.ScotCampbell.com / DRE #00943759

Important – This article is Not Intended to be specific advice: Receiving rent or installment payments tends to be more beneficial under the tax code when ordinary income is low (often when people are retired). Do NOT sell a highly appreciated property without advice from a CPA or Tax/Legal Expert who understands your complete situation. Advice and counsel of a Realtor and Qualified Mortgage Broker who are familiar with the IRS rules, lending regulations, & best practices are an absolute necessity prior to entering into a purchase contract involving an Installment Sale.

Advice for home owners • December 8, 2022

SPECIAL REPORT: What can Homeowners Facing A Big Capital Gain Tax Liability do to “Sensibly Make a Move” ?

by Scot Campbell

What can a capital gain tax conscious homeowner do to sensibly “make a move” when their Highly Appreciated home is no longer consistent with their lifestyle or budget?

Real Estate Marketplace Observations by Scot Campbell – Real Estate Broker

Background: The sale of a significantly appreciated personal residence often requires the payment of substantial capital gains tax on the profit exceeding the $250,000 per spouse IRS Section 121 threshold. Some long-term homeowners are fortunate enough to have much more appreciation: $1 to $4 million is certainly not uncommon in Coastal Orange County. There is little appetite for such long-term homeowners to sell when capital gains taxes can take 38+ per cent of the profit over the $250,000 per spouse threshold.

Rent Out Existing Home, then Buy or Rent a More Suitable Home: A very simple option is to rent out the existing home, and then Buy (if you can qualify without the sale of the existing home) or Rent a home which is better in terms of location, layout, size, and monthly budget. Rental income from existing home funds the payments (or rent) on the new home.

Important: The existing home reduced capital gains rate (IRS section 121), $250,000 profit exemption per spouse, expires on the 3-year anniversary of the date you move out (so selling before the 3 year deadline is advisable). Or, once the existing home is considered a “rental” under the tax code, you could potentially do a 1031 Tax Deferred Exchange into another rental property which has better cash flows or is better located for ease of management. When the existing home is rented out for the long run or exchanged into another rental, the equity in the existing home has been converted to “an investment” which generates income. The rental income is taxable, but capital gains taxes are deferred.

Sell Existing Home using a Traditional Installment Sale: One well known strategy for homeowners (who own their home Free & Clear) is to defer and potentially lower capital gains taxes by breaking up the cash flows from the sale over several years using a Traditional Installment Sale (Seller Carry Back Loan). Home sellers like that Interest income from the carry back loan is higher than a bank savings account, and it is nice to collect interest income on money that would have been paid in taxes (if all proceeds were paid out at close of escrow). Although a large down payment can reduce risk to acceptable levels, some home sellers do not like the risk of missed or late payments and would prefer not to worry about an “early payoff” (which would trigger capital gains taxes).

Sell using a Structured Installment Sale: A strategy with less credit risk which homeowners are using to break up the cash flows from the sale over several years is the “Structured Installment Sale” with installment payments made by *A+ Rated Life Insurance Company. Unlike a Traditional Installment Sale, the (annuity) payments are reliably made, and there is no risk of an early payoff.

Other things homeowners like about Structured Installment Sales: The house does not have to be Free & Clear. At closing, the buyer obtains a new loan (or pays cash), and the existing mortgage is paid off. A “chunk of money” can be taken out of the escrow to buy another home (verify tax considerations for these funds), then the balance of the escrow proceeds are taken in the form of reliable monthly installments (annuity from *A+ Rated life insurance company at possibly a much lower capital gains tax rate than if all the funds were paid at the closing).

Important – This article is Not Intended to be specific tax advice: Receiving rent or installment payments from either type of Installment Sale tends to be more beneficial under the tax code when ordinary income is low (often when one is retired). Do NOT sell a highly appreciated home/investment property or attempt to do a 1031 Exchange, Installment Sale, or Structured Installment Sale without advice from a CPA/Tax/Legal Expert who understands your complete situation. Advice and council of a Realtor and Qualified Insurance Broker who are familiar with the IRS rules & best practices are an absolute necessity prior to entering into a purchase contract involving a Structured Installment Sale. *A+ Rating from AM Best.

____________________________________________________________________________________________________________________________________

SCOT CAMPBELL | Global Luxury Property Specialist | Coldwell Banker-Campbell Realtors

714.336.0394 Mobile / scot@campbellrealtors.com / www.scotcampbell.com / DRE #00943759

Advice for home owners • December 8, 2022

SPECIAL REPORT: What is IRS SECTION 121 and How is it applicable to the sale of your home?

by Scot Campbell

The Section 121 Exclusion is an IRS rule that allows you to exclude from taxable income a gain of up to $250,000 from the sale of your principal residence. A couple filing a joint return gets to exclude up to $500,000.

To get the exclusion a taxpayer must own and use the home as their main residence for a period adding up to two years out of the five years before it is sold. Verify the date(s) of your occupancy of the home with your tax advisor based on past tax returns.

The Section 121 Exclusion, also known as the principal residence tax exclusion:

It lets people who sell their primary homes put the proceeds from the sale into another home without having to pay taxes on the gain.
There is no requirement that proceeds from a home sale be used to purchase another home in order to claim the exclusion.
U.S. taxpayers also qualify for the principal residence tax exclusion if the principal residence is outside the United States.

What type of sales do not qualify for Section 121?

The exclusion is tailored to deny similar tax benefits to investors who buy homes for rental.
People who sell secondary residences such as vacation homes cannot use the exclusion.

The main restriction on using the Section 121 exclusion is the ownership and use test.

This requires that the taxpayer has owned the home and used it as a primary residence for at least 24 months out of the previous 60 months. The 60-month period ends on the date the home is sold. The 24 months do not have to be consecutive.
For instance, a taxpayer could qualify for the exemption if the taxpayer lived in the home for a year, moved out for three years, and then used it again as a primary residence the last year. Also, the ownership and use tests can be met during different two-year periods.
A homeowner who uses the home for business purposes, such as rental property, for part of the preceding five years would only be able to excluded a portion of the gain, however. The amount of the gain that can be excluded is determined by the proportion of time the home was used for business purposes. For a taxpayer who lived in a home for two of the five years and rented it for three of the five years, for example, three-fifths of the gain on the sale could not be excluded. That portion of the gain would be treated as income.
Another limitation on the exclusion is that the taxpayer can only use it every two years. If a taxpayer sold a home and took the exclusion at any time during the two years before the date of the home’s sale, the exclusion wouldn’t apply.

Special Exemptions for change of employment and health issues:

There are some special cases when a home seller can use the exclusion test more liberally. For instance, when a home seller has had a change of employment or had health issues or experienced other unforeseen circumstances.
There is also a specific provision for taxpayers or their spouses who are serving in the military and have been stationed for more than 90 days more than 50 miles from home or ordered to live in government housing. In these cases, the taxpayer can elect to suspend the usual five-year period for up to 10 years. A similar exemption applies to taxpayers or spouses in the government foreign service or intelligence community.

Summary: A home that has been a principal residence for 2 out of the last 5 years and was not a rental for any of that period can qualify for significant tax reduction using the Section 121 Exclusion

Section 121 allows the excluding from income up to $250,000 for an individual taxpayer and $500,000 for a couple filing jointly. The exclusion is only for people who own and use a property as their primary residence for two of the five years before the sale.
Section 121 cannot be used by real estate investment properties, rental houses, second and vacation homes, or business property.
Section 121 can only be used once every two years.

For additional information please contact your tax expert and review IRS guidance: https://www.irs.gov/taxtopics/tc701

Advice for home owners • December 8, 2022

SPECIAL REPORT: How PROPOSITION 19 affects property taxes on inherited property

by Scot Campbell

In California, parents or grandparents may transfer their primary residence to their children or grandchildren without the property’s tax assessment resetting to market value.

However, Proposition 19 only provides exemption from tax reassessment when the transferred property was the primary residence of the qualifying parent(s) or grandparent(s) and the child or grandchild continues to occupy the home as their primary residence.

A homeowners exemption must be applied for within one year of the qualifying transfer.

Proposition 19 eliminates the parent-to-child and grandparent-to-grandchild exemption in cases where the child or grandchild does not use the inherited property as their primary residence and thus, the inherited property not used as a primary residence is no longer able to be transferred without a tax reassessment to market value.

This provision of Proposition 19 went into effect on February 16, 2021.

Advice for home owners • December 8, 2022

SPECIAL REPORT: State of California PROP 19 Q&A

by Scot Campbell

California Assn of Realtors | Prop 19 Q&A

How does Proposition 19 benefit California’s housing market, provide tax savings for homeowners and create new homeownership opportunities?

Homeowners who are 55+ or severely disabled can transfer the property tax base of their existing home to another home anywhere in California, regardless of price, to be closer to family or medical care, downsize, or move to a home that better meets their needs without a property tax increase (with an adjustment upward to their tax basis if the replacement property is of greater value).
Allows wildfire victims to transfer the property tax base of their damaged home to a replacement home anywhere in California.
Creates housing opportunities to build more senior housing and retirement communities.
Opens up more housing inventory in neighborhoods throughout California, providing homeownership opportunities for renters, young families, and first-time homeowners.

What are the new rules for homeowners to transfer their low property tax base to another home under Prop 19?

Older homeowners, those who are severely disabled, or victims of wildfires or natural disasters can move anywhere in the state without location restrictions.
Qualified homeowners can transfer their existing property tax base to another property regardless of the cost of the replacement home (with an adjustment upward to their tax basis if the replacement property is of greater value).
Homeowners can transfer the property tax base of their existing home to a replacement home up to three times.
The original property and the replacement property must be the principal residence of the homeowner.

Who is eligible to access these new tax benefits?

Homeowners who are 55 years or older
Severely disabled
Victims of California wildfires or natural disasters

How does Prop 19 work when purchasing a new home for the same price (or less) than the original home?

Transferring Tax Benefits to a New Home Across County Lines: If the purchase price of the replacement home is equal to (or less than) the sales price of the existing home, even if the replacement home is in another county, the tax base of the replacement home will remain the same as the original residence. (“Sales price” means full cash value.)

Example #1:

A senior couple on a fixed income lives in a home valued at $600,000. They pay $2,200 in property taxes (based on the $200,000 original purchase price). They find a $600,000 home to purchase near family in another county but can’t afford the new $6,600 annual property tax bill that comes with moving – it could cost $4,400 more in annual property taxes to move.

Under Proposition 19: The senior couple can purchase the $600,000 home in another county without a property tax increase. Prop 19 allows these homeowners to transfer the tax base of their original home to the replacement home, saving $4,400 in annual property taxes.

How does Prop 19 work when purchasing another home that costs more than the sales price of the original home?

If the sale price of the replacement home costs more than the price of the existing home, qualified homeowners can blend the tax base of their original home with the tax base of the new home. The new, adjusted property tax base of the replacement home takes the tax base of the original home and adds the difference between the sale price of the new home and the original home. (“Sales price” means full cash value.)

Example #2:

Another senior couple with a home valued at $600,000 (also paying $2,200 in property taxes) wants to downsize from the two-story home that is too big for their needs, is too expensive to maintain, and has stairs that are difficult for them to use. They want to downsize to a more manageable home in a newly built retirement community nearby for $700,000, but they can’t afford the $7,700 spike in property taxes that comes with moving.

Under Proposition 19: This couple will save $4,400 in annual property taxes. Prop 19 allows homeowners to keep their existing Prop 13 tax base and transfer it to a more expensive home. The property tax base of the new home is determined by adding the difference between the sales price of the replacement home ($700,000) and the original home ($600,000) to the tax base of the original home ($200,000). In this example, the couple would pay $3,300* in property taxes, instead of $7,700 in property taxes. (*The tax savings could be greater depending on the definition of “equal or lesser” value). Prop 19 Sample

What was the law before the enactment of Prop 19?

Under Prop 60 and Prop 90, seniors and disabled homeowners faced location and price limits, were restricted to transfers within the same county (with some exceptions), could only transfer if the price of the replacement home was less than or equal to the value of the original home, and were only allowed one transfer.

If an eligible homeowner used their one-time base year value transfer under Proposition 60/90, can they transfer that base year value three more times under Proposition 19?

Yes, according to the Board of Equalization,* three transfers under Proposition 19 will be allowed regardless of whether a property owner transferred a base year value in the past under Propositions 60/90 and Proposition 110.

Future legislation may impact the operation of Proposition 19 and any updates will be posted on the Board of Equalization’s website.*

The Board of Equalization has posted on its site the above FAQs addressing the purchase or sale of property prior to April 1, 2021. These questions are qualified with the following disclaimer:

Proposition 19’s provisions will become operative on February 16, 2021 (intergenerational transfer exclusion) and April 1, 2021 (base year value transfer).

Unfortunately, Proposition 19 did not have companion legislation that would have clarified a host of issues. Therefore, these frequently asked questions (FAQs) are intended to help property taxpayers navigate those new provisions in light of Proposition 19’s lack of clarity or silence.

It is anticipated that these FAQs will be updated periodically with additional questions, particularly if legislation is enacted or further guidance is issued by the Board.

Please check back often for updates. https://www.boe.ca.gov/prop19/#FAQs

The information contained herein is intended to provide general information and is not intended as a substitute for individual legal advice. Specific examples used are only general examples, and the actual amount of property taxes owed for any person will depend on the specific situation of the individual and a wide variety of other factors. Therefore, all persons are directed to seek the advice of an attorney regarding their specific tax and legal situation.

Advice for home owners • November 3, 2022

SPECIAL REPORT: When Markets Shift, there are always people who benefit from the new conditions… Who are the “Winners” in today’s market?

by Scot Campbell

Market Observations By Scot Campbell – Real Estate Broker ~ Source: Freddie Mac & Reports on Housing

BACKGROUND: Home Prices skyrocketed from July 2020 through February 2022. Buyers & many Sellers benefited from mortgage rates that dipped all the way down to 2.86% in September 2021… but then the mortgage market began to increase. The Federal Reserve raised the federal funds rate 300 basis points from 3/17/22 to 9/21/22, another 75 basis point increase expected on 11/2/22. These actions increased mortgage rates to 7.08% (10/27/22 FreddieMac).

Today, most homeowners have a very low mortgage rate on their existing home, thus are not motivated to move. According to Steven Thomas (Reports on Housing): 89% of homeowners have a mortgage that is 5% or lower…71% have 4% or lower… and, 29% have 3% or lower. According to the California Association of Realtors ~ Housing Affordability Index, only 12% of prospective buyers could afford to buy the Median Priced home in June 1022 when mortgage rates were at 5.81%. Now that rates are above 7%, affordability has fallen further (assuming buyers elect to limit their financing choices to a Confirming 30 year fixed rate loan).

Given the shift in market conditions outlined above, there are two classes of property owners who could be considered “Winners” from these new conditions:

LANDLORDS: Sometimes when you decide to move, it makes sense to keep your exiting home as a rental, especially if you qualify to buy without the sale of the old home. Many “would be” buyers for a home like yours, can no longer afford to purchase… so instead, they are going to rent. The economic principle of the substitution effect has kicked in strong. There are now many more prospective tenants for your property: Greater demand means higher rents and a more financially qualified pool of prospective tenants.

Important consideration if you rent out your former principle primary residence: The reduced capital gains rate (IRS section 121), $250,000 profit exemption per spouse, expires on the 3-year anniversary of the date you move out. If you want to take advantage of IRS section 121, end the lease no later than 2.5 years after you move out, so you have a “comfortable” 6 months to get your old home sold (and enjoy $250,000 in capital gains per spouse tax free).

Landlord/Tenant laws/enforcement were affected by Covid-19, so selecting a highly qualified tenant is more important than ever before to insure reliability of rent payments. I offer leasing service with excellent tenant screening and the same high quality imagery package as my For Sale listings… Reach out if you would like more information.

HOMESELLERS WHO WANT RELIABLE INCOME AFTER THE CLOSE: For years, sellers of real estate have used Installment Sales (seller carry back financing) to reliably collect income after selling a property… they also did it to defer and minimize capital gains taxes. When rates were very low last year, buyers had no interest in seller carry financing (because most carry back sellers expect to be paid off in 5 or 10 years… buyers prefer not to have a balloon payment), and sellers certainly were not excited about a 2.86% interest rate. But now, with a qualified buyer, sizable down payment and/or Blanket Encumbrance, sellers who carry back financing can get an excellent after-tax return & reduce risk to a level well below other investments. Research shows approximately 42% of the potential move-up buyers are sitting with lots of equity and an existing mortgage between 3% & 4%… these are buyers who would pay top dollar for your property if they could get an interest rate close to what they have now. I am already seeing property owners benefiting from the Market Shift by doing Installment Sales. Once again, there is an abundance of qualified buyers with strong down payments and the ability to make reliable mortgage payments… And, this is exactly what some property sellers want because a standard sale with all profits realized in the year of sale could trigger a very large capital gains tax bill (as much as 38%, perhaps more if the property is highly appreciated).

If you would like to explore the benefits of doing an Installment Sale, I can answer your questions and compute the approximate income payments you will receive depending on the sale price, amortization, and interest rate. Please contact me, I am happy to speak to you on the phone or in person.

Important – This article is Not Intended to be specific advice: Receiving rent or installment payments tends to be more beneficial under the tax code when ordinary income is low (often when people are retired). Do NOT sell a highly appreciated property without advice from a CPA/Tax/Legal Expert who understands your complete situation. Advice and counsel of a Realtor and Qualified Mortgage Broker who are familiar with the IRS rules, lending regulations, & best practices are an absolute necessity prior to entering into a purchase contract involving an Installment Sale.

Advice for home owners • October 26, 2022

SPECIAL REPORT: Here are the techniques Successful Sellers use to relocate when the housing market slows down

by Scot Campbell

What did Southern California homeowners “who needed to move” do the last time there was a housing market slowdown coupled with high mortgage rates?

By Scot D. Campbell, Broker | Coldwell Banker-Campbell Realtors | Southern California

CAR Housing Affordability Index 2022Q2

Background: It was June 1990… I had been working in Property Management while in college, and just graduated from CSUF with a degree in real estate finance. It was time for me to start working full time in the real estate industry. After a real estate market peak in late 1989, the Southern California market headed into a deep slump that did not end until 1995. Why? We had a regional economic recession related to defense cuts (about 300,000-500,000 high paying jobs lost between 1986 and 1993 according to the LA Times). While the economy in other parts of the country was on a positive growth path, Southern California employment was struggling.

There were home owners who needed to sell their homes to accept employment elsewhere and others who needed to sell for various other reasons. The average mortgage rate was 10.13%.

Many home owners decided to hire knowledgeable real estate agents (like me) to get the job done using ethical and responsible Traditional and Creative Techniques which allowed home owners accomplish their housing goals.

There is nothing more traditional than “Just renting it” when a homeowner wants to move elsewhere during a “slow market”. Here are some considerations and important future dates to remember:

Lease the Home: One of the fantastic investment aspects of owning property is that it can be “leased out” for income if a homeowner decides they need to move to a more suitable home. The most important aspect of leasing is finding a tenant who will pay the rent on-time and look after the home. This is especially true today when evicting a non-paying tenant is more difficult than ever before, and since our national economy is intentionally being slowed down by the Federal Reserve. Another consideration is section 121 of the IRS code which allows homeowners to exempt $250,000 per spouse from capital gains taxes provided the home was your principal primary residence 3 out of the last 5 years. If the lease term goes beyond 3 years, you no longer qualify for IRS Section 121. Any homeowner who wants to get the equity out of the property within a few years, has a significant capital gain, and wants to reduce or eliminate taxes on their gain should terminate the lease and target a sale/closing of the property within about 2.5 years of moving out of a principal residence (it is risky to go right upto the 3 year deadline). Leasing Service is something I have been offering my clients ever since I entered the business working for my father who was a “Certified Property Manager.

Sometimes homeowners have no interest in becoming a traditional landlord, so “renting it out” is not the answer.

That is when Creative Marketing can come into play during a market slow down. Creative techniques center around offering convenience or terms which allows a buyer to purchase a property when they otherwise would not.

In the next few pages, I will outline the techniques that I observed in the early 1990s… the last time we saw a peak in home prices in Southern California followed by a slowing market with high mortgage rates.

Let’s talk about two very traditional conveniences that a home seller can offer to a buyer to increase the probability of a sale during a slower market:

Allow a Contingency for sale of buyer’s property: During the seller’s market we experienced in 2021, the only offers considered were All Cash and offers not contingent on the sale of the buyer’s home. However, there are many potential buyers who must sell their home first in order to buy. These buyers had zero chance of buying a home in 2021… there were multiple cash/non-contingent offers on every home. If you allow buyers the convenience of putting their home on the market and selling it after they have found your home, there will be more potential buyers for your property. As a realtor, I am very careful to do research on the buyer’s home to make sure it is likely to sell, and I limit the length of a continency period and extensions are only considered after a careful market review of the buyer’s home and their activity. I may structure the agreement as a “first right of refusal” in case another offer arrives which is worth considering.

Trade: If a buyer for your home already has their old home in escrow, perhaps that buyer would be keen to purchase your home. But, sometimes in a slow market, buyers do not want to put their property on the market because they think it will not sell or the process would be difficult due to occupants, tenants, etc. Thus, they will not make an offer on your home even though they would love to own a home like yours. What if you are a “great buyer” for the property they need to sell in order to buy your home? It happens, and we call these “Trade Transactions”. Sometimes the buyer’s property offers the opportunity to down size or is suitable as a second home/rental. Over the years I have been involved in Trade Transactions and I know how to structure these “convenience” sales.

When the real estate markets slow down, creative techniques may also center around offering terms which allow a buyer to purchase when they otherwise would not.

There are many cases where the home seller would really benefit by offering creative terms. The key is to offer security to the seller and opportunity to the buyer.

Installment Sale: With a sizeable down payment (and/or additional security via a blanket encumbrance) a home seller may elect to carry the financing on a home they are selling. This technique is ideal for sellers who own their property free & clear (or small enough mortgage balance to pay off with the buyer’s down payment). Often sellers accept “interest only” installment payments when there is substantial capital gains on the home (exceeding the $250,000 per spouse exemption)… this allows the seller to collect interest on money which would have already been paid to the IRS in capital gains taxes. The interest collected by the seller on an installment sale can be very substantial as compared to putting the proceeds of a standard sale (after taxes) into a bank account. And, given recent gyrations in the stock market, many sellers might welcome a reliable return on their money. I can project an annual rate of return if you would like to see some numbers. Good things do not last forever… Eventually, when the loan is paid off, the capital gains taxes are due.

Lease Option: Homeowners who have a very low mortgage rate and assessed tax value have a very sweet deal going. For a variety of reasons (moving out of area, do not want the hassle, maintenance concerns, possible eviction) many homeowners are reluctant to become landlords. There are cases when those homeowners have very high tax capital gains tax burdens if they sell their home. If you rent the home out for a couple years (converting it to an investment property), then do a 1031 exchange (into an investment property) the capital gains taxes can be deferred. When a lease-option is structured correctly (big upfront option money, extendable term, reasonable strike price), the tenant/optionee treats the property like they own it, and at the end of the option period is nearly certain to exercise the option (take title to the home). There are so many ways to structure a Lease Option in terms of the Option Money, Term, Strike Price, Extensions… and, I can answer your questions.

Yes, there are lots of alternatives to the “standard home sale” when the market slows down.

Rent it out, Contingent Offers, Trade Transactions, Installment Sales, & Lease Options all come to mind as alternatives.

Offering the convenience of a contingency to a buyer does not cost anything, or you may be a “great buyer” for a property owned by your buyer.

Would you benefit from the tax benefits & income offered by an Installment Sale? Is your tax situation something that indicates you would be wise to lease (or lease/option) your home even if you are a reluctant landlord?

Should you do a 1031 exchange into a rental? Or, should you lease it then sell it before the 3 year IRS section 121 deadline?

Which one is best for you in today’s market if your home does not sell as a standard sale? There is certainly a lot to consider.

Fortunately, I know the answer… but I will not be able to give you the best alternatives until I have listened carefully to your goals and situation. I am happy to meet with you in person to discuss your situation and explain the benefits of these standard sale alternatives.

Even if you elect to do a Standard Sale in the end, you will have the peace-of-mind that you checked out all of your options.

Contact me direct by cell phone: 714-336-0394 or via email: Scot@CampbellRealtors.com.

Note: There can be significant negative tax & financial consequences when transactions are not structured properly. Do not attempt to do any of these alternatives without the help of an experienced realtor, attorney, and tax planner who know the applicable laws, best practices, and forms necessary to complete the transaction.