Tax Laws for Rolling Investment Properties Into a Primary Home

Selling investment properties can cause you to incur taxes on the profit. The federal government allows you to defer the taxes owed to a later date by "exchanging" properties or, more accurately, rolling over the funds from one real estate investment to another. However, involving your primary home in the rollover transaction cannot be accomplished in the same way as buying an investment property, and it requires close attention to the rules to ensure that you are not taxed on your capital gain.

Capital Gain

The Internal Revenue Services (IRS) defines a capital gain as the difference between the cost of the asset and the sale price. When determining the cost, you can increase the basis by adding in capital improvements. You also may deduct any capital losses on your investment property. However, if you make a profit, any amount realized is subject to a tax of 15 percent for real estate held more than one year and at the rate of your regular income tax for shorter-term gains, as of the date of publication.

1031 Like-Kind Exchange

The IRS has special rules for capital gains on investment properties that you would like to pay later instead of when they are sold. This allows you to use all of the gain that you realized to obtain other investment real estate. IRC Section 1031 lets you roll your profit from one property into another of the same value or more, as long as your debt service is the same or higher. You also are able to sell and purchase more than one property at a time to qualify for the exchange. The transaction must be completed within 180 days of the sale, and the money has to be deposited with an intermediary who completes the trade for you. You cannot receive any funds or you may incur a tax on that amount.

Primary Residence

Since you must roll an investment property gain into other investment real estate, the IRS does not allow you to defer your capital gain tax by selling an investment property and rolling the profit into a house in which you will live. However, the IRS allows you to avoid capital gain tax on your primary residence when you sell it if you have lived in it for any two out of the last five years. As of the date of this publication, you do not have to pay taxes on a gain of up to $250,000, or $500,000 for married couples, when selling your primary home.

Process

In order to roll an investment property gain into a primary home, you must first rent out the new property to tenants after you make the like-kind exchange. After you use the house as an investment property for a year or more, you can move into it and make it your primary residence. Even though you are not allowed to make a direct exchange into a home of your own, you can make a legitimate trade to a property that you will occupy after it is used as an investment.

References

• IRS.gov: Ten Important Facts About Capital Gains and Losses
• IRS.gov: Like-Kind Exchanges Under IRC Code Section 1031
• Cornell University School of Law: Exclusion of Gain From Sale of Principal Residence
• 1031 Exchange Made Simple: A 1031 Exchange That Can Involve Your Personal Residence
• 1031 Corporation: Investment Property-to-Personal Residence Rollover