If you plan to sell a substantially appreciated asset, property or business, you can save money  with what's called a "two-year installment sale." Basically, it's a double-sale strategy to create a "taxation timing gap" between when the asset sale proceeds are received and when they're taxed.

Here's how it works: You can sell the asset to your children or to a separate trust (sometimes referred to as a "deferred sale trust") on a long-term installment sale. That way, your children or other beneficiaries can receive the full value and enjoyment of the property before the gain is recognized and subject to taxation. At that point, the property can be sold to a third-party buyer for cash.

For example, let's say you own Blackacre, an investment property with a basis of $200,000 and a fair market value of $1 million. If you sell it to a non grantor trust (T) for the benefit of your children in exchange for a 10-year or even 30-year installment note, T receives a stepped-up basis of $1 million for Blackacre. You receive two payments of $100,000 from T and recognize a gain of $80,000 on each payment. After the second payment is made, T sells Blackacre to an unrelated taxpayer (U) for cash. Assuming that the value of Blackacre has increased by $100,000 between the two sale dates, the value is now $1.1 million. T recognizes a gain of $100,000 on the sale to U. The family receives the entire $1.1 million of value while paying tax on only $300,000 of the $900,000 gain. T will continue to pay off the note over the next eight or even twenty-eight years. You recognize any gains and pay the taxes over that period. This provides a significant timing difference. Plus, you may also be able to reduce your taxable income and pay taxes from a lower tax bracket in future years.

This strategy is beneficial because the gain is taxed at a reduced rate as a long-term capital gain instead of a short-term capital gain, which would be taxed as ordinary income. And your beneficiaries still receive all the cash proceeds in the year of the second sale. Also, this strategy provides an opportunity for a far greater overall return. If you invest the funds you might have otherwise paid in taxes in the year of the original sale, you might earn 6% or more each year on that amount.

Without this strategy, capital gains taxes on sold assets can be substantial. For example, the maximum marginal capital gains rate for a California resident is 37.1%, including both federal and state taxes, while the maximum income tax rate is 57.1%. So minimizing those taxes can pay off substantially.

Two-year installment sales can also be used to avoid the 3.8% net investment income tax (NIIT) because it provides a lower overall tax liability and allows owners to pay that liability over a long period of time. Do take note, however, that this alternative is not available for the sale of marketable securities, such as publically traded stock or equities.

Unfortunately, Congress partially shut down this strategy when IRC Section 453(e) was enacted. But you can still take advantage of it if you're patient. After you sell the asset to your children or a trust, you have to wait at least two years and one day to resell it to a third party for cash and enjoy the benefits described above.

Capital gains taxes can be a huge drain on proceeds from asset sales. But if you can be patient enough to wait two years and one day, two-year installment sales can be a great strategy for reducing your tax bill.

To view the full article on Kiplinger's website please click here.

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