Patrick owns a home in Leawood that he inherited 10 years ago when his father passed away. Since that time, Patrick has been renting the home to various tenants. Patrick has grown weary of his tenant and landlord relationships over the years since he has had several tenants who have been consistently late with their rent payments, and he even had one tenant who had to be evicted due to nonpayment of rent. Also, the tenants have caused considerable damage to the property over time and many aspects of the home are in disrepair.

Regardless, the value of the home has increased considerably since his father’s passing primarily due to the value of the underlying land. Recently, Patrick was approached by a real estate developer who wants to purchase the home at a price substantially more than the home’s value as determined by his father’s passing. The developer wants to demolish the current property and build a large new home that will be held for sale to a prospective buyer.

Patrick is concerned about the amount of taxes he will have to pay if he sells the home to the developer. Patrick still thinks real estate is a great investment and wants to consider investing the proceeds from the sale of the home in a multi-tenant apartment complex that will be professionally managed and provide a more consistent flow of income. The developer tells Patrick that he may be able to defer the gain on the sale if he invests in other real estate and Patrick has sent you an email asking your advice.

Draft a short email back to Patrick explaining the general rules for deferring the gain on the sale of the home and what considerations he needs to take in order to avoid immediate federal income tax consequences.