How to Reinvest the Profits From the Sale of a Rental Home

Selling an investment property can leave you with a large tax bill, especially if you make a significant profit. You can avoid the tax by reinvesting the profit from the sale. It's important to act in a timely manner. Failing to invest the sale proceeds or not following the Internal Revenue Service guidelines leaves you responsible for paying taxes on the entire profit.

Capital Gains

Capital gains are the difference between the amount you sell a home a home for and the amount you originally paid for the home. On your primary residence, the gain is exempt up to $250,000 for a single owner and $500,000 for married couples. When you sell an investment property, you will be subject to a capital gains tax. If your property lost money and you claimed the loss as a deduction on your tax bill in previous years, you will face a higher tax bill after selling the home.

IRS Requirements

IRS Section 1031 lets you avoid the gains tax by reinvesting the profit into a similar property, such as another investment home. If you aren't ready to immediately invest in another home, sale proceeds are placed into an escrow account until you line up another property. The IRS gives you 45 days to find the property and six months to close the deal. If you plan to reinvest, it's a good idea to begin searching for another home before selling your rental property since you are racing against the clock.

Intermediaries

Before you sell your investment property, you must set up an exchange agreement with a disinterested party, known as an intermediary. The intermediary you select can't have any business relationship with you. A current attorney, accountant, real estate agent and tax adviser are excluded. There are no license or certification requirements that must be met. Title companies and banks can often serve as intermediaries responsible for holding the sale proceeds until the replacement property is purchased.

Corporations

Certain investors may benefit from becoming incorporated. If you employ others who locate and manage rental properties for you and make a profit from it, becoming a corporation can result in a lower tax bill since the corporation tax bill is separate from your individual taxes. If the income from your properties isn't exceeding your expenses for each property by a significant margin, it will not be worth it to become incorporated.