Consider an installment sale when selling your investment property in today's market

After a long and successful run the New York real estate market has begun to slow down. This coupled with the slowing overall economy and the recent upheaval in the banking and brokerage industry have led some real estate owners to consider selling some of their investments. A key consideration while planning for this should include the potential impact that November's presidential election will have on the income tax due on the gains from sales. As of today the federal tax rate on long term capital gains is at an historic low of 15%. Coming January 2009 a new administration will take office and be faced with large deficits, continuing wars in Iraq and Afghanistan and lower tax revenue due to the economy. Whether the winner is republican or democrat they will need to craft a fiscal policy that addresses these problems. This mix may lead to an increase in the tax rates for both regular income and capital gains. Traditional tax planning normally centers on deferring the tax until some future date. The above facts may defy this logic. If the property's value has peaked and you foresee a disposition in the near future it might be time to consider selling prior to December 31, 2008. An outright sale will give you the combination of high market value and lower tax rate that may yield a result far in excess of waiting until next year. There are those who would like to take advantage of the high market value but not necessarily have an immediate taxable event. This result can be achieved by crafting an installment sale with the buyer. In an installment sale the seller receives an initial down payment and an installment obligation or mortgage from the buyer. This method will also offer the seller a significant bargaining advantage with the buyer in a tight credit market. Since the seller is taking on the role of both seller and banker there are additional risks and responsibilities that the seller must be willing to accept. One of the principal risks for the seller is that the buyer will be unable to pay the mortgage but with a sufficient down payment and adequate due diligence and indemnification from the buyer the seller should be satisfied. Under the installment method the tax is paid by the seller as he collects the sales proceeds from the buyer. Use of the method is mandatory unless the taxpayer elects out. The election is made with the tax return for the year of the sale. For example a December 2008 transaction will be reported on an individual's 2008 tax return which is due as late as an October 15, 2009. This would give the seller an extra nine and one half months to determine what is best with regard to reporting the gain on the sale. Special rules apply to items such as depreciation recapture but generally the character of the gain is unchanged by electing the installment method. Use of the method remains in effect for the life of the obligation; therefore, if there are future increases in the tax rates the taxable gains reported in those years will be taxed at the higher rate. For taxpayers with pre-existing installment sales, there are certain events that can cause an immediate recognition of the remaining gain. For example if the obligation is sold or pledged as collateral it is deemed to be fully collected. This will offer the taxpayer an opportunity to spring the tax should the situation call for it. Recognizing the time value of the installment method the Internal Revenue Code imposes an interest charge based on the federal underpayment rate, on the deferred tax on the aggregate face value of installment obligations in excess of $5 million as of the close of the taxable year. As with any business transaction taxes should not be the ultimate deciding factor but under the current circumstances the possibility of the tax rates changing must be considered. We urge you to consult with your tax advisor before proceeding with any transaction referenced herein. Sandy Klein is a partner at Shanholt Glassman Klein Kramer & Co., New York, N.Y.