Different tax rules apply for various types of property in various states, but in general, if you sell one property then purchase another, all the taxes will be due the year the sale occurred.

On the other hand, an increasingly popular "tax deferring" strategy is for real estate owners who are selling one property and acquiring another in the same tax year is to use Section 1031 of the Internal Revenue Code. If you arrange to exchange one investment property for another, it is possible to defer the Capital Gains Tax owed through the 1031 tax-deferred exchange. It is an effective way to defer paying income tax on capital gains generated by the sale of a property when you intend to reinvest the proceeds in a similar, "like-kind" property.

Almost any kind of real property is considered "like-kind" with any other real property. However, a recently enacted law closes what was considered a loophole in the Section 1031 rules. In some cases, owners of investment real estate have used the 1031 Exchange to swap their investment property for real estate that could be readily converted to an owner-occupied residential property. After the exchange, they made the property into their principal residence, lived in it for a couple of years, then sold it. Now the American Job Creation Act of 2004 has ruled that properties converted from a 1031 exchange property into a residence must be held and used as a principal residence for at least five years to qualify for the tax exemption. Otherwise, the basic tax-deferring benefits of 1031 exchanges remain the same.

To ensure complete tax deferment you must acquire a replacement property which is equal, or greater, in price than your exchange property, and move all of your equity from the old property into the new one. It is not as complicated as it sounds, but you will need the help of professionals.

A few real estate agents and attorneys specialize in helping their clients put these 1031 tax-deferred exchanges together, and TEAM MIKE can assist you if you decide to pursue this route.

Last Updated: June 15, 2007