Sometimes the owner of a rental property may want to sell one investment and purchase another. The difficulty here lies in the fact that those who have owned their properties for a long time may realize large capital gains when they sell their properties and be liable for the associated capital gains tax. There are essentially two ways to sell your rental properties and avoid paying tax; you can either use the primary residence exclusion or a 1031 exchange.
Eliminate the Tax by Using the Primary Residence Exemption
Determine whether you are eligible to use the primary residence exemption. To qualify, you must have lived in the property for two out of the last five years, and you can't have used the exemption at any time during the two preceding years.
Convert the rental property into your primary residence by moving in and actually using it as a primary residence for a minimum of two years.
Calculate the capital gain, and if it is less than $250,000 for an individual or $500,000 for a couple, then you can use the exclusion and pay no capital gains tax.
Defer the Capital Gain Tax Liability Through a 1031 Exchange
Find out if your property can qualify for 1031 exchange by understanding whether it has been held for investment purpose or for a productive use in a trade or business.
List your property for sale and enter into an agreement with a 1031 exchange accomodator to facilitate your 1031 exchange.
Complete your transaction and deposit the funds from the sale into a trust account owned by the facilitator.
Identify up to three potential replacement properties and give notice to the facilitator of the addresses of the properties within 45 days after you sell your original property.
Purchase one of the properties you identified to complete your 1031 exchange within 180 days of when you sold your original property. As long as the property you purchase is of equal or greater value when compared to the property you sold, then you have completed the exchange.
Hire a good tax adviser to help you with either of these choices.
Joel S. Hinckley has many years of experience in both commercial and residential real estate and is a published author on the topic of 1031 exchanges and Tenants-in-Common investing. Hinckley has been involved in numerous successful start-up business ventures and is an expert on Marketing, Strategy, and International Trade and Finance. He earned his MBA from the University of Pittsburgh. He is currently working as COO of a real estate valuation company.