Pay no tax when you sell your farm, rental, or investment property  

Don't overlook one of the biggest opportunities in real estate today!  Exchanging is the tax code's most powerful reward for owners of investment or business property.

Exchanging 
In general, an exchange is accomplished by selling your property and buying another. The process is much simpler than most people think. It's really just a sale and a buy, with a few curve balls tossed in for good measure.  

It might be the word "exchange" that confuses people. Instead of "exchanging", the process should be called "continuing". If you merely continue your investment, the IRS says, "Okay, since you're continuing your investment you don't have to pay tax on your gain at this time." Your gain is carried forward to replacement property. If you someday sell the replacement property, the gain would be taxed then. But, instead of selling what could you do? Exchange again! If you kept doing this your entire life , all the gains would be forgiven when you die because of the "stepped-up basis rules."  

As long as the only thing you receive in the exchange is "like-kind real property" you're merely "continuing" your investment and gain is not taxed. "Like-kind real property" is any property held for investment or use in a trade or business. Therefore, you could exchange your office building for raw land, your farm for an apartment building, etc.  

If you receive any "unlike-kind property" part, or all, of your gain may be taxed. The three types of "unlike property" are: 1. Cash. 2. Book (defined as "any non-cash asset" i.e. a boat, a car). 3. Net loan relief (when you owe less after the exchange than did before the exchange) in which case , the amount of difference is taxable.  

Now let's talk about the mechanics of an exchange. Again, everyone's situation is unique, so be sure to get good legal and tax advice before you actually do an exchange. Also, keep in mind that I'm going to simplify the process and show you one way to do an exchange.  

The first step is to put your property up for sale. That's right, for sale. The reason is that the owner of the replacement property that you want probably doesn't want your property - he or she wants your cash equity. And how do you convert your equity into cash? By selling your property.  

Now you may be thinking, "If I sell my property I have to pay tax on my gain." But here's he good part. If you clearly demonstrate that your intent is to do an exchange, the rules allow you to sell your property. But instead of receiving your equity proceeds (which would be "unlike property") at the closing, these proceeds are placed in to a qualified escrow account. You don't receive the money and you don't even have the right to withdraw or use the money from the escrow. The beauty of this arrangement is that, yes, you've sold your property and converted your equity into cash but you haven't received any unlike property. This is called delayed exchange.  

To complete the delayed exchange you must meet two time tests: 1. You have 45 days from the day you sold you're property and the money was placed in the qualified escrow to "identify" a replacement property. 2. You have 180 days to actually acquire the replacement property  
Now, it's not 45 days plus 180 days. Both of the time periods begin on the day you sell the old property.  

Look at the power of this! By doing a delayed exchange, you sold your old rental/business property, the proceeds were placed into a qualified escrow account, you identified a replacement property (within 45 days) and you purchased the replacement property 9within 180 days).  

It's really just a sale and a buy, but it's treated as an exchange. And, so long as the only thing you receive is like-kind property, you don't have to pay tax on your gain! Fantastic!  

Many title companies, escrow companies and exchange facilitators are geared up to be the qualified escrow holder. If you're searching for a company to act as your qualified escrow holder, merely call them up and ask them if they handle delayed exchange. (If they answer something like "Well, ahh, most of our closings get delayed" you've called the wrong company!)  

Once the dust has settled, you have sold your old property and purchased another. But, if you do it right, you're treated as if you did an exchange. And, if the only thing you received is like-kind property, you're merely "continuing" your investment, and you don't have to pay on your gain!  

Combination Property 

What if you own a property that's a combination property, for instance a farm? It's actually two types of property: the farm house is a primary residence and the farm is a business property. Instead of selling the farm and paying huge capital gain tax, you could use the two-year rollover or the one-time exclusion for the farmhouse, and exchange the business part of the farm for other like-kind property (maybe and apartment building that produces income). The result would be no capital gain.