Tax-Deferred Cash Out
of Primary Residence
We received an inquiry from a homeowner who was planning to sell her high-end single-family dwelling at a substantial gain, well in excess of the amount that would be covered by her federal homeowners exclusion of $250,000. She wondered whether there was any way to defer her capital gains tax and still come away from a sale with a significant portion of the sales proceeds in cash. She intended to move into assisted living but was concerned that the capital gains tax burden would substantially reduce her cash resources going into her new living situation.
Facts and Circumstances
Sale price (net of selling costs): 2.3 million
Cost basis: $475,000
Federal capital gains tax exclusion: $250,000
Adjusted gain: $1,575,000
Federal and state tax: (CA = 37%): $582,750
Net sales proceeds after tax: $1,717,250
Factors Affecting Use of Tax-Deferred Cash Outs with Sale of a Primary Residence
1. Sale price (should be at least $1 million)
2. Capital gain amount: should be at least $500,000, after considering the tax benefit of any homeowners capital gain exclusion ($250,000 for single taxpayers, $500,000 for married taxpayers.
3. Existing debt: if there is any, then the owner will need to pay it off from their own cash resources, rather than using any proceeds from the monetization loan, because home loans are considered "personal" and the monetization loan is considered a business loan, with tax-deductible payments for business purposes.
4. Purchase of another primary residence: the monetization loan proceeds may not be used for this purpose, again, because it would be considered "personal use," so cash proceeds from a business loan would not be allowed.
We invited the homeowner’s accountant into the conversation to make sure our proposal was vetted by her tax advisor. We proposed that the homeowner engage in a tax-deferred cash out, which would defer the capital gains tax and leave her with substantially additional cash at closing.
The property is sold on a 30-year installment sales contract to a dealer, with interest-only payments and a final balloon payment of principal.
The dealer immediately resells the property for cash to the originally-intended end-buyer, under the same terms and conditions set forth in the seller’s purchase and sale agreement.
The seller is introduced to a private lender who is willing to lend, concurrently with the installment sale transaction, and amount equivalent to 93.5% of the seller’s net sales proceeds. This loan features terms that mirror those of the installment sale contract with the dealer, with interest-only payments on a monthly basis and a final balloon payment of principal at the end of the 30-year term.
The payments from the dealer are used by the seller to fund the payments to the lender, monthly and at the end of 30 years, so that all payments to and from the seller are equal and offsetting.
The capital gains tax becomes due at the end of the 30-year installment sale term when the final payment of principal is made to the seller.
Meanwhile, the seller has the use of the tax-free cash obtained up front via the monetization loan.
The seller accepted our proposal and sold her primary residence using a tax-deferred cash out.
Cash proceeds from regular sale: $1,717,250
Cash proceeds from the tax-deferred cash out: $2,150,500
Additional cash obtained via a tax-deferred cash out: $433,250
Note: This transaction was possible, in part, because:
The amount of capital gain was sufficient to make the transaction economically viable;
There was no debt against the property. (If there was, she would need to pay off that debt from her own resources, and not using proceeds of the monetization loan, so that the interest on the monetization loan proceeds would be deductible);
The seller was not planning to use any cash from the monetization loan to purchase another primary residence. If that was her intent, it would be a problem from a tax standpoint, because the monetization loan is considered a business loan and a primary residence is considered “personal use.”