How To Avoid Capital Gains Tax When Buying US Property

Can you avoid capital gains tax by buying another house?

Before May 7th 1997, you could avoid paying tax on your home sale’s profit if you used the money to buy a more expensive house within a 2 year period and rolled the gain into that house. But that’s not the way it works any longer. Now, capital gains tax is assessed on a per-sale basis.

Is there still a way to avoid capital gains tax on US property?

If you sell your primary home, you may exclude up to $250,000 of your capital gain from tax ($500,000 if you’re married, filing jointly). However, you must have owned and lived in the home as your primary residence for at least 2 of the last 5 years before the sale.

If you’ve been living overseas, and the US home has not been your primary residence, then this exclusion will not apply to you. For instance, if you’ve been renting US home for 3 or more years before you sell, you will have to pay capital gains on the sale of that property.

What about real estate investments?

If you’ve held real estate as an investment, you can use the 1031 exchange to defer capital gains tax. The 1031 exchage allows you to trade one real estate investment for another real estate investment and incur no immediate tax liability. Assuming all the right financial tests are met. So what are those tests?

1. No gain or loss is recognized until the newly acquired property is sold. So if you sell one condominium and buy another condominium, you’ll recognize any gain or loss when you sell the second condominium.
2. Like-kind property must be of the same nature, character or class. The quality or grade of the property doesn’t matter. Think residential property, residential property. Commercial property, commercial property. Generally speaking, most real estate will be like-kind, other real estate investments.

Foreign real estate and US real estate don’t mix

One exception to this is that property within the United States will not be considered like-kind to property outside the United States. You can’t sell your U.S. real estate investment and purchase a foreign real estate investment and have this considered a 1031 exchange.

How to use the 1031 exchange

When you do a like-kind exchange, you must find another piece of suitable real estate within 45 days after the sale of the first property. Then you must commit to purchase this, in writing. Not with the seller, but with the disinterested third party who acts as an intermediate. In tax terms, the disinterested third party, means he or she cannot have any sort of business relationship with you. They can’t act as your real estate agent, your accountant, your attorney. They have to be completely disinterested.

To use the 1031 exchange, you need to close on the new property within 180 days. The seller cannot touch the sales proceeds. Those funds have to be held by a disinterested third party for the entire time.

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