How to Reinvest Capital Gains on a Second House Sale for a New House

Many exchanges have simulatneous escrow closing.

Buying and selling real estate can lead to sizable capital gains when properties appreciate significantly. If you are selling a second house to buy a new one, this qualifies as a tax-free exchange under Internal Revenue Service code 1031, also called a 1031 Exchange. Follow all protocol to ensure the exchange doesn't result in a taxable event. Qualified exchanges are "like kind" meaning real estate is exchanged for real estate. It doesn't matter what type of real estate it is -- house, land, commercial or residential. The exchange is tax-free, although taxes are deferred to when the property is sold.

Instructions

1. Hire a 1031 Exchange Facilitator who serves as the intermediary required by the IRS to complete the tax-free exchange. Ask your realtor or lender for qualified recommendations since this is an unregulated area in real estate. Complete all forms assigning the facilitator to the right to sell the initial property and purchase the new one.

2. Identify a new property to buy within 45 days of selling the initial property. You can select more than one property to allow yourself options if you decide not to follow through on a property after inspections.

3. Calculate the purchase price to ensure that it is equal to or greater than the sale price of the initial property.

4. Keep the sale assets of the first property with the facilitator. Money cannot cross though your possession at any time during the transaction to comply with 1031 Exchange rules.

5. Complete the purchase of the new property within 180 days of closing the sale of the initial property.

6. File IRS Form 8824 with your personal tax return to record the Like-Kind Exchange and avoid large capital gains payments.

Tips & Warnings

• Most 1031 Exchanges are either simultaneous or completed shortly after the completion of the first sale. It is possible to preform a reverse exchange where the new property is purchased just prior to the sale of the initial property as long as the facilitator and all parties in the transactions are informed the sale is a 1031 Exchange.

References

• IRS.gov: Like-Kind Exchanges
• IRS.gov: Form 8824
• 1031 Exchange Made Simple: Considering a Tax-Deferred "1031 Exchange"