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It is called a like-kind exchange under Internal Revenue Code, Section 1031, “when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or ‘like-kind’.” Under this rule, you are allowed to defer the taxes that you owe on the sale of the first property. This means that you can sell one rental property in order to invest those earnings in another property that meets your needs better.

The 1031 Exchange allows you to defer the taxes due when you sell one property for another property of like or greater value. In the event that a property of less value is purchased, there could be tax implications. It is very important to discuss your plans for taking advantage of a 1031 Exchange with a professional to ensure you will meet all the criteria.

Why is this great for investors?

The equity that you have built in your current rental can be really helpful in funding a new property with even more income potential. Given that the cost to sell a property can be around ten percent of the sale price, deferring your taxes on those capital gains may give you the extra leverage you need to afford upgrading your rental. The like-kind exchange allows you to re-invest your equity in a new rental property.

Fine Print

As with every IRS transaction there are quite a few conditions in order to qualify under the Like-Kind Exchanges rule.

  • You have only 45 days to declare your next property and six months to close.
  • You can only declare up to three properties for every one property sold without additional restrictions.
  • Both properties must be held for business or investment purposes, not for personal use. “Flip” properties  do not qualify.
  • Because the process can be cumbersome and fraught with red tape, it is critical to read the pertinent IRS regulations, and speak with a professional to execute the sale and subsequent purchase correctly.

    Conclusion

    1031 Exchanges are a great way to grow your rental portfolio while deferring the taxes. Just be sure to have knowledgeable, experienced professionals to lead you through the process.