This unique transaction is a well-known secret to real estate investors. Would you believe that you could legally defer the taxes on your real estate investments? Its called a 1031 Exchange.  The 1031 exchange allows the investor to roll over all his or her net proceeds to another real estate investment.

Here are the steps for the 1031 Exchange

• After you sell your property, you must give all of your net proceeds to the 1031 exchange agent to hold in escrow. This agent must be independent from your attorney, accountant and broker.  The agent must be a part of an escrow company or a bank.  You cannot pull any of the profit out of this account for personal use, this is called booting.
• You must locate a property of like kind, meaning that it must be an income-producing property.  For example, an investor sold an office building on the first sale, but redirected their new investment for an apartment building.  You could even buy 2 properties in exchange for the one property you have sold.
• You must close on your target property within 180 days from the date that the other property sold.
• You must apply ALL of the escrow proceeds to your new investment property.

How does this really work in your favor?

For example, the investor netted $60,000 from their first property.  They now invest that $60,000 as a 10% down payment towards a $600,000 property, following the 1031 exchange rules.  Four years later, the investor sells that property and nets $160,000.  The investor now can roll over that $160,000 along with the $60,000 down payment to apply as a 20% down payment for a million dollar property.  In essence, the IRS is allowing you to build your investment portfolio tax-free!