For investors who use their properties to generate revenue, this exclusion is not available. However, the IRS provides another avenue to defer the tax liability for a time by reinvesting the sale proceeds into another like-kind property, called a Section 1031 Exchange. Business entities can also use this vehicle to protect assets.
The simplest exchange is a simultaneous swap of one property for another. If the exchange does not happen at the same time, a qualified third party will hold the funds from the sale of the first property until they can be used toward the purchase of another. Several rules govern this process.
First, the seller must identify, in writing, one to three replacement properties within 45 days of the closing of the sale. All three properties may be purchased in exchange, or they can be treated as back-up options should one of them become unavailable after identification. The purchase of the replacement property must be completed within 180 days of the initial sale.
There are other rules related to the value of the replacement homes identified and the percentage of the value that is actually acquired in the final sale. In addition, if there is still additional money left after the purchase of the replacement property, that gain, or "boot," could be subject to taxation. It is highly advisable to hire an exchange service to account for all funds and handle this sometimes complex transaction. These experienced professionals can also help you make long-terms plans regarding the best way to handle or even reduce the deferred tax liability. If you would like a referral, don't hesitate to contact me.
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