Whenever you sell a house at a profit, you must report it to the IRS and pay the appropriate capital-gains tax unless it’s your main residence and you qualify for the exclusion. However, if you use the sale proceeds to purchase another house that is “like-kind,” you can defer recognition of your taxable gain until you sell the second property.
The like-kind exchange rules apply only to property that you hold as an investment or use in a business. Additionally, it must be tangible property that is eligible for annual depreciation deductions. This can include rental houses and other properties you hold for investment purposes. It doesn’t include, however, the houses you own for personal use, such as your main residence or vacation home. However, you can eliminate, rather than defer, up to $250,000 of the gain ($500,000 if married) you recognize when you sell your main residence under separate tax rules, if you own and use the home as your principal residence for at least two years during the five-year period that ends on the date of sale.
In order to defer the capital-gains tax on the sale of your house, you must exchange it for property that is of like-kind. When you sell real estate, like-kind property includes all other types of real estate, even if not a house. For example, you can exchange your house for a vacant tract of land and still qualify for like-kind exchange deferral. However, exchanging your house for an automobile doesn’t qualify as a like-kind exchange. And if you don’t exchange the house for other property in a single transaction, the tax law limits the amount of time you have to reinvest the proceeds from the sale of the house in like-kind property.
Like-Kind Exchange Timing
You must receive the like-kind property within 180 days of completing the sale of your house to defer the tax on the gain. However, the IRS also requires that you identify the property within 45 days of selling the house. For example, if you plan on reinvesting in another house, you must have a written agreement to enter into the transaction of a specific house within 45 days and complete the transaction within 180 days. If you start looking for a house on the 50th day and complete the transaction on the 100th day, you will not qualify for the like-kind exchange deferral.
Basis Remains Same
Once you complete the exchange, your basis in the new property is the same as your basis in the house. This is to insure that you eventually pay tax on the gain when you sell the new property. To illustrate, suppose you purchase the house for $100,000 and sell it for $200,000. If you reinvest the funds in a new house that is worth $200,000, your basis in that home is still $100,000, not $200,000. To insure you keep track of your initial tax basis, the IRS requires that you prepare a Form 8824 and attach it to your return in any year you take advantage of a like-kind exchange.
- IRS: Publication 544 - Sales and Other Dispositions of Assets; March 2011
- IRS: Publication 523 - Selling Your Home; Jan 2011
- IRS.gov. "Like-Kind Exchanges - Real Estate Tax Tips." Accessed Sept. 27, 2020.
- IRS.gov. "About Form 8824, Like-Kind Exchanges." Accessed Sept. 27, 2020.
- IRS.gov. "Instructions for Form 8824," Page Two. Accessed Sept. 27, 2020.
Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.