I have a rental property which I have maintained for a few years. Now I have an opportunity to sell it and buy another rental property closer to my house. How much do I have to worry about capital gains when I sell?
You might not have to worry about capital gains at all if your transactions qualify for a 1031 exchange.
Seasoned real estate investors have likely heard of the 1031 exchange, though many have never used it. Also known as a like-kind exchange, this is a tactic that allows you to defer paying capital gains on the sale of a property.
Sound too good to be true? Don't worry, there are plenty of rules and hoops to jump through — but if you can master them, the 1031 exchange can help you build substantial wealth.
In the exchange, you reinvest proceeds of a sale into a similar property. According to the IRS, the exchange can include like-kind property exclusively or it can include like-kind property along with cash, liabilities, and property that are not like-kind.
Primary residences and vacation homes do not qualify.
The exchange is sometimes a simultaneous swap of properties, but not always. There are two time limits to meet before the gain is taxable.
First, you have 45 days from the sale of the first property to identify your next purchase. There are a number of guidelines for how to do so and who to notify.
The second time limit, according to the IRS, is that "the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier."
Make sure to work with a professional who can walk you through the process and properly handle all paperwork. If done right, however, an investor can continue rolling profits over indefinitely and even pass the wealth along to his heirs.
