When you own a second home or investment property, the Internal Revenue Service allows you to reinvest the earnings from the sale of the property so that you do not have to pay capital gains taxes. This process is known as a 1031 exchange and it can help you save a substantial amount in taxes. To make this work, you will have to invest the money you make in another similar property according to the rules of the exchange.
Sell your property and allow an escrow agent to receive the money from the sale. At this time, you do not have to immediately reinvest the money from the sale to qualify for the tax break. A third party must keep the money throughout the process.
Identify potential properties that you would like to invest in within 45 days from the date of sale. You can identify up to three properties that you would potentially like to purchase. More than three properties can be identified if the total amount does not exceed 200 percent of the value of the original property.
Enter into a contract to purchase a property. For this part of the process, it will be just like you are buying a property in a traditional manner. You will make an offer on the property and if it is accepted, the seller will require you to enter into a contract to purchase it.
Complete the transaction within 180 days of closing on the original property. On the date of the closing, the escrow agent or third party will transfer your money to the owner of the property. You will then take ownership of the property.
Fill out Form 8824 when you file your tax return for the year. This is how you must report the like-kind exchange to the Internal Revenue Service so that you can avoid capital gains taxes.