Capital Gains and 1031 Exchange

Kevin Lu can help you save money on your home sale by avoiding paying taxes using these steps.

Managing the Initial Sale

You could mitigate this tax burden by controlling the year in which title and possession passes and, therefore, the year in which you report the profit or loss on the transaction. In other words, you can set the transfer of ownership to a year in which you expect to have a lower tax burden. However, if your income is steady and paying tax on the gain looks inevitable, you may want to consider using the IRC Section 1031 exchange.


The Section 1031 Exchange

The Section 1031 exchange allows an investor to trade real estate held for investment for other investment real estate and incur no immediate tax liabilities. Under Section 1031, if you exchange business or investment property solely for a business or investment property of a like-kind, no gain or loss is recognized until the newly acquired property is sold. Keep in mind that Section 1031 does not apply to exchanges of inventory, stocks, bonds, notes, evidence of indebtedness, and certain other assets.

Beginning in 2018, new tax legislation limited these exchanges to real estate: Section 1031 exchanges of other property, such as artwork, are no longer permitted. For more clarity, refer to the IRS.

Rules and Regulations

The Section 1031 exchange will not allow the avoidance of capital gains taxes in all cases. For example, the exchange of U.S. real estate for real estate in another country will not qualify for tax-free exchange status. Furthermore, trades involving property used for personal purposes—such as exchanging a personal residence for a rental property—will not receive the tax-free treatment afforded under Section 1031. Finally, if either party subsequently disposes of the exchanged property within a two-year period, the exchanged property will become subject to tax.