How To Avoid Capital Gains Tax When Buying US Property

Years ago, capital gains tax was a huge topic in the US real estate world. Today, the subject is less controversial but also a bit more unclear, as the rules have changed since 1997. David McKeegan answers one reader’s question about how quickly you need to use a capital gain from a property sale to avoid the ensuing tax.


Hi everybody. I’m David McKeegan with Greenback Expat Tax Services and our question today is: how long do you have to use a capital gain from a U.S. property sale to invest in another property without paying tax?

Well, before May 7th 1997, the only way you could avoid paying tax on your home sale’s profit, was to use the money to buy another more expensive house within a 2 year period and then you could roll that gain into that house. But that’s not the way it works any longer. Now it’s on a per-sale basis. So if you sell your primary home, you may exclude up to $250,000 of your capital gain from tax and this is $500,000 if you’re married, filing jointly. There is one caveat. 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. You have to have actually lived in the house for 2 of the last 5 years, in order to be able to exclude $250,000 from the capital gains tax.

If you’ve been living overseas, and the US home has not been your primary residence. You’ve been renting it out for 3 or more years, then this exclusion will not apply to you and you will have to pay capital gains on the sale of that property. If you’ve held real estate as an investment, you can use the 1031 exchange, which allows you to trade real estate held for investment for other real estate held for investment and incur no immediate tax liability. Assuming all the right financial tests are met. So what are those tests?

No gain or loss is recognized until the newly acquired property is sold. So if you sell 1 condominium and buy another condominium, when you sell the second condominium, that’s when you have recognized any gain or loss. The definition of like-kind property is a property 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.

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.

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. 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.

That’s all this week. If you have any other questions, please let us know. Thank you very much.


Free Guide: 25 Things Every Expat Needs to Know About Taxes

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