Avoid Capital Gains Tax When Selling Investment Property

Did you know that it may be possible to avoid paying immediate capital gains taxes when you sell an investment property?

For instance, suppose you own a condo as an invest­ment, and you plan to sell it and use the proceeds to buy another investment property. You might be able to treat the sale and the subsequent purchase as a “wash,” and de­fer paying any capital gains tax on the first property until you sell the second property. This is known as a “like-kind exchange,” or sometimes as a “1031 exchange” (after the section of the tax code that allows this).

There are some restrictions. For instance, the second property must be of a “like kind” – although it doesn’t have to be the exact same kind of property. In general, you have to identify the second property within 45 days of selling the first property, and you have to close on the second property within 180 days of selling the first property. (In some cases, though, you can identify several properties within 45 days, as long as you close on one of them.)

Also, the proceeds from the initial sale must typically be held by a specially qualified third party while they’re waiting to be used to purchase the new property.

In certain cases, it may be possible to close on the sec­ond property even before you sell the first property.

In the past, 1031 exchanges almost always involved real estate, but people are increasingly using them for other types of investment property, such as art. However, in or­der to qualify for such a tax break, you would have to show that you’re actually in business as an art investor – simply selling a painting in your bedroom and replacing it with a new one probably wouldn’t qualify.

A 1031 exchange can be complicated, and there’s a lot of technical paperwork. But it might well be worth the effort if you can defer a significant capital gains tax.