Generally when flipping property we do not need anything but transactional funds in order to close on the property and get paid. Up front costs are minimal. Do more than one or two a year and income will be taxed as ordinary income.
The time will come for almost every investor when it makes sense to actually purchase the property to use for a rental or lease option to produce some steady cash flow. In time, the Investor will want to sell either to invest elsewhere, to buy a different type of property or a larger property. How can one sell in order to use the proceeds for something else without incurring a huge capital gain?
A way to defer capital gains and finance new investment purchases is to use tax-deferred like-kind exchanges as described in Section 1031 of the U.S. tax code.
Section 1031 allows taxes to be deferred when property used in a business or trade or for investment purposes are exchanged for property of the same kind within 180 days. The replacement property must have been identified in writing within 45 days of the sale of the first property. An exchange agent must be used whenever the exchange is not simultaneous to avoid the taxpayer ever handling the funds.
Property used as a primary residence or a secondary home that has not been rented out for the purpose of profit is not eligible. Mere appreciation of an asset is not sufficient to call the property an exchangeable investment—there must be a business purpose such as use primarily as an office building or as a rental.
If extra cash is added in order to complete the exchange then that extra cash, called the “boot,” is not deferred and gain on that portion must be recognized upon sale. The “boot” may include cash received back at closing, cash paid for service costs that were not part of the closing costs, borrowing that was done in excess of what was needed to purchase the replacement property, or any personal property that is not like-kind received at the exchange.
Don’t exchange out of class– real property for personal property–however you can exchange vacant land for one with a house built on it, if the intent for both is a business purpose or money-making investment. One could sell a couple rental homes on a 1031 exchange in order to purchase an interest in an apartment building, within the specified time limits. Judicious use of the 1031 exchange to buy and sell property to be held for investment purposes is a great way to keep more of the profit.