33 Guidelines for investing in real estate.....

Guideline #28:   Don't sell, exchange.

Unlike your personal residence, when you sell an investment property, you create an immediate tax consequence.  Whether it is a capital gain or ordinary income depends on the time frame involved, but come April 15th, you will be settling with the Internal Revenue Service.  The fact that you might re-invest in another investment property is immaterial.  If you sell, the tax is due.

The government, however, in its infinite wisdom, has recognized that business owners and investors may need to get out of one property and into another, and that said business owner or investor may need to preserve their equity in the former to get into the latter.  Enter the IRC Section 1031 Tax Deferred Exchange.  This section of the tax code allows an investor to "exchange" from one property into another while deferring any tax on any gain.

The rules are fairly simple.  The seller of a property held for trade or investment (the "relinquished property") who wishes to re-invest in another property held for trade or investment may do so without immediate tax consequences provided those rules are followed.  The seller cannot have "constructive receipt" of the sale proceeds (their money gets held by a "qualified intermediary"), must identify the property they will be re-investing in (the "replacement property") no later than 45 days after the conveyance of their original "relinquished property," and must take title to the "replacement property(s) no later than 180 days after the sale of the original property.   If you follow the rules, the exchange will effectively defer any tax due until such time that the investor finally sells out.

This is generally considered a good thing.  It allows a seller of a smaller investment property to use and preserve their equity to acquire a larger investment property.  Exchanging is an important tool in the building of a solid portfolio of investment real estate.  Use it.

It should be noted that using the Section 1031 Tax Deferred Exchange is not a do-it-yourself kind of venture.  You will need professional help.  Fortunately, it is available.