Dear Mr. Azrael:
In 1994, my husband and I sold a rental property, a townhouse which we had owned as an investment property since 1987. We used the "like-kind exchange" method to roll over the capital gains into a new purchase -- a condominium which is also an investment property. We avoided paying any taxes as we had no capital gain.
We own another townhouse that is also a rental property we purchased in 1986. If we sell this property, would it be possible for us to roll over the capital gains into the above-mentioned condominium we already own?
L. Morgan Carey Baltimore
Dear Mrs. Carey:
No. You can't exchange property you sell in 1999 for a condominium you purchased five years earlier.
The "like-kind exchange" regulations of the Internal Revenue Service code allow only a 180-day window to complete an exchange of one investment property for another.
These regulations must be followed to the letter to obtain favorable tax treatment. As I mentioned in a January 1999 Mailbag, a tax-free exchange is a complex transaction. It should not be entered into without competent legal and tax advice.
The main requirements for a tax-free exchange are:
The real properties involved in the exchange must be used in a trade or business or held for investment.
You can't exchange an investment property for property you use as your new home.
There must be an actual exchange of properties. Selling your property and reinvesting the proceeds in another property will not qualify for tax-free exchange treatment.
You can sell one property and purchase another within 180 days through a Qualified Intermediary, which holds the sale proceeds in escrow and uses them to acquire the exchange property.
You must adhere to the IRS regulations governing Section 1031 exchanges.
If a tax-free exchange is properly structured and executed, you will carry over the tax basis of the relinquished property to the property you receive in exchange.
You still will pay capital gains tax on any "boot" -- proceeds of the relinquished property that you do not spend on the replacement property.
Your tax accountant or attorney should be consulted to provide complete information on the subject.
A helpful booklet on real estate exchanges is available on the Internet at www.irs1031exchanges.com.
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