Q: My husband and I have owned some real estate for 27 years. It is vacant land and never had any improvements. We sold it in early 2007 and made a profit of about $350,000. Our yearly income from a small pension and Social Security is about $30,000. The property nest egg was intended to take care of us for the remainder of our lives. Do we have to pay the Alternative Minimum Tax on that since it was a long-term capital gain? If so, is there any way to reduce it or defer some of the tax? The sale has closed and we put the proceeds into CDs, which pay an average of 4.85 percent interest.
- B.S., via e-mail
A: Your gain is taxed at the long-term capital-gains rate. But you also have to figure what your AMT will be on this extraordinary gain, says Dean Barber, president of Barber Financial Group in Lenexa, Kan.
Think of it this way, he says: The AMT is much like a flat tax of 28 percent. You get a few large deductions and write-offs, but whatever is left is taxed at 28 percent. So, on your gain of $350,000, 28 percent equals a large number ($98,000). But you still had a nice profit.
To reduce this tax, Mr. Barber makes the following suggestions:
•Take capital losses. If you have any stocks or mutual funds with capital losses, sell them before year-end and realize the loss.
•Consider retirement plans. If you have earned income, maximize contributions to any of your retirement plans, such as a 401(k), 403(b), or a traditional IRA.
•Think charity. A percentage of your charitable contributions will offset the AMT.
•Take advantage of deductions. Take all your standard tax deductions this year and accelerate any deductions that you plan to use next year. One positive note is that this sale will create a large carry-forward credit that you could use in the future if you have other property to sell. But you're probably like the thousands of others who will come to realize the shocking effect of the AMT, and this is the only large sale you will ever make in your life.
It's too late for this parcel, but here are two proactive ways that Barber says could be used to avoid this tax problem:
1. Installment payments. Provided you trust the buyer and are sure you will get your money, you could have split the sale over two or more years. In your case, since you indicated you sold this in early 2007, you could have taken payment for half in December 2006 and the other half in January 2007. That splits your gain in half over two years.
2. A 1031 exchange. In the IRS code, you are allowed to use the 1031 exchange provision to sell a real estate property and exchange it for another property and avoid, or at least defer, all taxes.
Now for the most important part to consider: your $250,000 nest egg. While earning 4.85 percent interest in CDs will certainly protect your principal, they won't protect your purchasing power when considering taxes and inflation, Barber says. He recommends that you meet with a financial planner and put together a more complete financial plan.
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