The tax deferral method most investment property owners use is the 1031 exchange. This IRS code tool encourages more active management of a real estate property portfolio; owners have more freedom to swap long-held properties for new, higher-yielding real estate while deferring capital gains and other taxes. So long as the owner wants to maintain real estate ownership, it can be a very useful planning approach to defer taxes.
At some point, however, a property owner may want to jump off this merry-go-round and no longer want to own property. He or she wants out and is looking for a viable exit strategy. This usually occurs when the owner wants to retire from active asset management and roll the accumulated asset values into more liquid investments to fund retirement. Or, perhaps they are forced to sell because of unforeseen events that have impacted their family. In situations like these a 1031 exchange is not a solution because it is a replacement strategy and requires the seller to purchase another property of equal or greater value than the one that was relinquished.
Jumping off the real estate ownership merry-go-round usually triggers that large deferred tax bill the moment the property is sold, escrow closes and the cash from the sale hits the bank account.
Or does it?
It really is pretty amazing what tax planning opportunities are provided in the tax codes.