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Page 1 of 2 Internal Revenue Code Section 1031 allows real estate investors to roll profits from one investment property into another investment property of equal or greater value without paying capital gains tax on the profit from the sale of the original property. The capital gains tax can be deferred indefinitely through a series of exchanges until the investor eventually cashes out. The IRS has strict rules that must be followed exactly in order to qualify for a tax-deferred exchange:
* The equity (property value minus loan balance) in the new property must be equal to or greater than the equity in the old property.
* The replacement property must be identified within 45 days after closing the sale of the old property.
* The purchase of the new property must be completed within 180 days after closing on the sale of the original property.
The investor cannot have constructive receipt of the sale proceeds at any time during this exchange period, or the money instantly becomes taxable income. This problem is usually avoided by paying a professional exchange facilitator to act as a middle man who holds the sale proceeds and executes the exchange documents.
Question: I own 50 percent of a house that I built and lived in for four years while I lived in Alaska many years ago. I also own a home in Marysville, and I'm in the process of purchasing raw land to build a retirement home. Can I make use of the 1031 tax-free exchange program to avoid paying capital gains tax on the sale of the rental house in Alaska with the intent to build my retirement home?
G.K., Marysville
Answer: The short answer is: It depends.
First, a little background: Internal Revenue Code Section 1031 allows real estate investors to roll profits from one investment property into another investment property of equal or greater value without paying capital gains tax on the profit from the sale of the original property. The capital gains tax can be deferred indefinitely through a series of exchanges until the investor eventually cashes out. The IRS has strict rules that must be followed exactly in order to qualify for a tax-deferred exchange:
* The equity (property value minus loan balance) in the new property must be equal to or greater than the equity in the old property.
* The replacement property must be identified within 45 days after closing the sale of the old property.
* The purchase of the new property must be completed within 180 days after closing on the sale of the original property.
The investor cannot have constructive receipt of the sale proceeds at any time during this exchange period, or the money instantly becomes taxable income. This problem is usually avoided by paying a professional exchange facilitator to act as a middle man who holds the sale proceeds and executes the exchange documents.
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