I was chatting with someone the other day who mentioned that she had sold a property in another state recently, but just found out that her income taxes are going to take about a third of her profit. Someone had told her she could transfer the gain into purchasing a different property and defer the tax. All true, but, unfortunately, the transfer of property has to be done in the right order to qualify for the tax deferral.
This maneuver is called a 1031 Tax-Deferred Exchange. There are many good sources for information on the details, including the Internal Revenue Service, which is where you should start: http://www.irs.gov/newsroom/article/0,,id=179801,00.html.
Here are some excerpts that show why you need to plan ahead to carry out one of these transactions:
"It is important to know that taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable.
"One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete.
"You can not act as your own facilitator. In addition, your agent (including your real estate agent or broker, investment banker or broker, accountant, attorney, employee or anyone who has worked for you in those capacities within the previous two years) can not act as your facilitator."
For those of you who like question and answer formats, here is another good site: http://www.1031.org/about1031/faq.htm. And here is the answer from them concerning my friend's situation:
"Q - If the taxpayer has already signed a contract to sell the relinquished property, is it too late to start a tax-deferred exchange?
A - No, as long as the taxpayer has not transferred title, or the benefits and burdens of the relinquished property, she can still set up a tax-deferred Exchange. Once the closing occurs, it is too late to take advantage of a Section 1031 tax-deferred exchange (even if the taxpayer has not cashed the proceeds check)."
A good real estate professional is like a good doctor. If you have an ongoing relationship with a doctor, and you tell her you are thinking of climbing Mt. Everest, she can probably let you know if it's a good idea. If you suffer from emphysema or some other breathing problem, she could either tell you it's too dangerous for you, or that you can change your medication and make it possible. The caveat is, you have to consult with your professional before you do it, not after.
If you are contemplating a real estate transaction, you could talk to your tax professional, your real estate professional, or your legal professionalbut why not start with the one who won't charge you for the consultation? You might think that simply selling your property should be a simple decision, and maybe it is, but as in this example, it could turn out to be costly.