Transferring Capital Gains to New Property

Appreciation on your real estate is certainly a good thing, but you can absolutely count on plenty of taxes when you go to sell it. This capital gains tax is a charge assessed on the positive difference between the sale price of the property and its original purchase price. The basis is the how much you originally purchased the property for, plus any costs of improvements and charges you experience during its sale. Though the IRS does not offer a capital gains exception for a real estate investment sale as it does for the sale of a private home, the IRS does afford a way for you to avoid the tax by shifting capital gains to new property.

About Capital Gains

Capital gains on real estate investments are expected to be paid in full during the year that the property is sold. If you have the intent to exit the real estate investment market when you make the sell, the tax is obligatory, and you have no option but to pay the bill in entirety. Although, if you are liquidating a real estate investment and have intent to acquire another, you can postpone paying capital gains tax through the use of IRS Code Section 1031 and instead of selling your property, exchange it for like-kind real estate.

Definition of Like-Kind

IRS Section 1031 defines like-kind properties as two real estate assets of a similar nature regardless of grade or quality that can be exchanged without incurring any tax liability. The IRS usually considers all real estate within the U.S. – regardless of improved or not – as like kind.

You can use Section 1031 to shift all capital gains to new real estate if the deal is pure and there is no monetary exchange. Alternatively, you could move a share of capital gains to new property if you also receive a sum of money, in addition to an exchange of property. If that were the case, you would be responsible for tax on the money you obtain.

Method of Exchanging

It is not necessary to set up the property exchange in advance. You can ready the property for selling, list it, sell it and then assign a capable intermediary, for example, a representative from your bank, to be responsible for the sale’s funds until the exchange occurs.

IRS requirements state that a qualified intermediary cannot be a family member, business partner or anyone you have a close, personal relationship with. Rather, the QI must be a member of an independent group whose sole affiliation with you is to act as a qualified intermediary.

Requirements for the Exchange

There are three main requirements identified by the IRS for managing a 1031 like-kind exchange:

1. The transaction must be a business-to-business or investment-to-investment exchange. Exchanging your investment property for a private residence is not allowed.

2. You have a time frame of 45 days from the transaction date of your investment property to find another and generate a written sales contract.

3. You need to conclude the transfer and finish the deal inside of 180 days of selling the investment property or by the date you file your taxes for the year; whichever happens first.

So although you cannot avoid taxes altogether, you can prolong the cost of capital gains, as long as you continue to acquire new properties and move them as you go.