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Delaying Capital Gains

Dear Phyllis,
 I enjoy your column and don’t believe you have yet addressed capital gains tax. My wife and I own a commercial (business) property which is leased. If we sell this and buy one or two houses or a duplex as rental property for equivalent value or less, do we have to pay any taxes as capital gain? Is there any time limit for the exchange transaction?     LCM

Dear LCM,
As I am a Realtor® and not an accountant I cannot offer tax advice and I recommend that you speak with a tax professional. I did run your question by John Sadd, managing partner of Sadd, Higashi, Shamma, a Glendale accounting firm and he advised:

What you are contemplating is called a “Tax Deferred Exchange” under Section 1031 of the Internal Revenue Code. What you accomplish by qualifying your transaction as a Tax Deferred Exchange is that you can delay the income tax (or as people tend to call it Capital Gains Tax) until a later date.

First to qualify, the properties traded for must be “like kind’ to the property received. The IRS has a very broad definition of “like kind” here- and your business property would be “like kind” to residential rentals.

For the gain to be completely deferred, the amount you invest in the new property must be at least equal to the net sales price of the property sold. If you have a loan on any of the properties you need to be careful that you do not take any cash out of the sales proceeds to keep your transaction fully tax deferred.

If the property you acquire costs less than the net sales price of the property you sold, some of the gain will be subject to taxes.

The proceeds from the sale must be transferred directly from the sales escrow to an “Accommodator.”  Your Realtor® or Escrow Company would be the best source for recommending one. The Accommodator holds your funds until they are needed to buy your replacement property. Ask ahead of time if they will pay you interest on the funds on deposit. Remember, the funds must be held by the Accommodator. If you withdraw any funds they will become taxable.

There are some “etched in stone” dates to be aware of. On or before 45 days after the closing of the sale of your property, you must identify to the Accommodator the property you intend to acquire. Then, you must close the purchase of the new property 180 days after the original sales date. There are other steps which your Accommodator will walk you through. There are no extensions to these dates available.

You may do an exchange that allows you to purchase the replacement property before the sale of your property, but we won’t tackle that here. Remember, the exchange only delays the tax. If you sell the new property you may have to pay tax on the original gain as well as the gain on the sale of new property.

This is a very general discussion of a complicated subject and can not be relied on for your specific transaction. Always consult your own tax advisor before attempting a Tax-Deferred Exchange.

  Phyllis Harb