Final answer:
Kelly can address the potential higher tax rate by using an installment sale to spread out the payments, reallocating interest or reinvesting the principal in tax-advantaged accounts, or selling the note early at a discount to capture the gain at current tax rates.
Step-by-step explanation:
To avoid the expected higher tax rate, Kelly can engage in an installment sale, whereby she reports the income from the sale of the property over several years as payments are received. This approach may allow her to take advantage of the current lower tax rates on the payments received before any potential rate hike. In addition, Kelly may consider reallocating the note's interest payments or reinvesting the principal upon receipt into other tax-advantaged vehicles such as retirement accounts, which could defer taxes or capitalize on lower tax rates within those accounts. Municipal bonds are considered a safe investment, and their interest rates are often competitive with other types of investments. Kelly can choose municipal bonds that have a maturity date that aligns with the due date of the note, ensuring that she can use the tax-free income from the bonds to pay off the note.
To mitigate interest rate risk and potential tax rate increases, Kelly might also consider selling the note to another investor at a discount before the tax rate goes up. This would allow her to recognize the capital gain under the present tax rates rather than risking a higher rate later. By doing so, she could also potentially secure a lump sum which she could invest elsewhere at her after-tax rate of return.