Rental Property As Tax Liability

Added March 24, 2008 by Ilyce R. Glink and Samuel J. Tamkin

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Summary: Homes used as rental property are considered investment property by the IRS. As an investment property, you can either pay the taxes owed upon sale of the property, or defer the payment of real estate taxes due upon the sale. If you choose to defer the taxes you owe, you'd utilize Section 1031 of the Internal Revenue Code.

Q: What are the best strategies to minimize the tax liability on a rental sale?

We bought a single family home and lived in it for a couple of years then rented it for the last 6 years. We'd like to sell it but are concerned about a hefty tax bill.

I own another home that we use as an office. Can I roll the gain from the first property to pay down the note on the office?

A: The rental property you used to use as a home is now considered an investment property by the IRS.

As an investment property, you can either pay the taxes owed upon sale of the property, or defer the payment of real estate taxes due upon the sale. If you choose to defer the taxes you owe, you'd utilize Section 1031 of the Internal Revenue Code. This section allows a rental property owner to sell the property and defer paying taxes upon the sale if the property owner sets up a tax deferred exchange, also called a like-kind exchange or Starker Exchange.

Unfortunately, a like-kind exchange would require you to buy a replacement property for the home you are selling. It would not allow you to sell the property and use proceeds from the sale to pay down the debt on one of your other properties.

You could only sell your first property and buy a replacement property or replacement properties. That replacement property or properties must have a value equal to or greater than the property sold and you would have to adhere to strict time limits in purchasing the replacement property.

Upon sale of the investment home, you would have to set up an exchange through a company that specializes in 1031 exchanges. All proceeds from the sale of the property would have to be held by that company.

You would then have 45 days from the date you closed on the sale to find and designate a replacement property and you'd have to close on the purchase of that new property within 180 days of the date of the sale.

In some instances, the 180 day time limit may shrink. Be sure you choose a knowledgeable and reputable 1031 exchange company.

Published: Mar 24, 2008

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