A Rental Property Sale and Defer Capital Gains
you sell your rental property, which is a “capital asset,” and book a
profit, the profit is called a “capital gain.” Zacks
wrote recently, “One problem with doing well with an investment is that the
Internal Revenue Service is usually waiting with its hand out at the end of the
transaction, expecting its share in taxes.” Typically, you’ll have to pay
capital gains tax on this profit, but there are some tactics that allow a rental
property sale and defer capital gains.
Rental Property Sale and Defer Capital Gains
- Match losses. Investors can realize losses to offset and cancel their
gains for a particular year. Savvy investors harvest capital losses as
they occur and
then use them on current and future taxes. For example, suppose you have a
realized loss of $ 50,000 on a land deal. If you sell a rental property for a
gain of $50,000, the two offset and you pay no capital gains taxes. Up to
$3,000 of excess losses not used to cancel gains can offset ordinary income.
The remainder of the loss can be stored and carried forward indefinitely.
Always seek tax and financial advice before making such moves.
- 1031 exchange. If
you have a rental property sale, you can defer capital gains and depreciation
recapture taxes by rolling the proceeds of your sale into a similar type of
investment within 180 days. This like-kind exchange is called a 1031 exchange after
the relevant section of the tax code.
Using a 1031 Exchange
shares eight rules for using the 1031 Exchanges.
The rule works for like-kind
properties in question must be used for business or as an investment. This
means the rule excludes primary residences, which are for personal use the
majority of the time. Like-kind property
also must be within the United States to qualify. For example, a seller
cannot use the proceeds from selling a hotel in the U.S. to buy a hotel in
London and expect to defer capital gains on the sale. Securities, stocks,
partnership interests, and other
financial assets are excluded from the definition of like-kind property.
- From the day you sell
your initial rental property, you have 45 days to find a property you wish to
- From the day you sell your initial rental property, you have 180 days to
close on a new property.
- You must purchase a property of equal or greater value than
the adjusted value (not the price value — but the adjusted cost basis when
taking into account depreciation less
commissions and closing costs) of the property you sold, or you will be
taxed on the difference.
- Warning: If you do not close on a
property within 180 days of selling your initial property, you pay
the capital gains tax on your initial property.
- During the interim of selling your first place and closing on
your second, you cannot touch/look at/get close to the profits from the
first place you sold. That money stays with a 1031 exchange facilitator
(qualified intermediary) and not, not, not with you.
- The old property and the new property must be sold and bought
by the same entity. Meaning, if you sell a property as John Smith, you
have to buy the new one as John Smith — and not as Smith, LLC.
- Experts can debate this point, but a good rule of thumb for
the majority of you is this: You must own your property for one year and
one day to make this 1031 exchange. Otherwise, The IRS will penalize you.
- There is no limit how many times you can roll a transaction
forward, avoiding paying capital gains taxes. Eventually, the end will
come, and you will pay your taxes.
These are the basics of a 1031 exchange. If you have more questions,
reach out to a 1031 facilitator, a trusted tax professional, or someone you
know and respect in real estate.
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