Rental property can be a great long-term investment while providing current income. However, they also can be a lot of work. And continuing the role of landlord during retirement can be downright exhausting.
Another consideration is if you have paid-off properties and/or own significant equity in them, selling them to bolster your retirement savings could result in a rather large capital gains tab. After all, you won’t qualify for the same exclusion as you would for a primary residence.
Charitable Remainder Trust
One strategy to consider is the use of a charitable remainder trust (CRT) – even if you’re not charitably minded. With a CRT, you donate rental properties directly to a charitable trust. Because charities are exempt from paying capital gains taxes, the trust can then sell the properties and invest the full proceeds in an income-producing portfolio. The way a CRT works is that you receive income derived from that portfolio each year for the rest of your life, as either a fixed percentage of the value or as a fixed dollar amount.
The bonus is that you’ll also benefit from an immediate tax deduction. The deduction will equal the fair market value of the assets, minus the present value of the estimated future income stream (calculated with an IRS formula). This deduction also can be carried forward for use in future year tax returns.
When you pass away, the remaining trust balance will then transfer to the charity(s) you selected. If you’re worried about cheating your loved ones out of an inheritance, consider using a portion of the income stream you receive to purchase a life insurance policy with comparable proceeds, naming your heirs as beneficiaries.
Example:
- Value of 5 rental properties: $1 million
- Capital gains saved: $240,000
- Tax deduction: $500,000 (which can be carried forward in subsequent tax years)
- Lifetime income: Approximately $60,000/year
- Annual premium for a $500,000 life-insurance policy: $9,000/year
1031 Exchange
Another way to offload rental property without paying capital gains is to make a 1031 exchange with another similar property. This is basically trading one piece of property for another of similar value, and it can include residential or commercial property, such as houses, condominiums, apartment buildings, land, marinas, retail stores, office buildings, bed and breakfasts, parking lots, golf courses, farms, trailer parks, and even certain timeshares.
Multiple properties can be combined to equal the value of one or more on the other side of the deal. If you’re thinking of moving from your primary residence, consider selling your current home to take advantage of the capital gains exclusion, and swapping your rental property for your next home of similar value in a 1031 exchange, which will also avoid capital gains taxes.