Are you thinking about changing up your real estate investments - looking for properties with better opportunity for appreciation or increased rental income potential, but you're worried about capital gains tax on the profits? Welcome to the world of the 1031 Exchange.

The Internal Revenue Code (IRC) 1031 Tax Deferred Exchange is a great way to sell your investment property and trade up to another investment property, tax deferred. And by investment property, we mean any property that’s not your principal residence or second home. Typically, it’s a rental that’s either residential, such as a house, townhome or condo, or commercial, like an office building, warehouse or strip mall or vacant land that’s either residential or commercial.

As of January 1 this year, a 3.8 percent Medicare tax on investment income went into effect. However, it only applies to those who exceed the following adjusted gross income (AGI) levels, a figure that currently excludes about 96 percent of all U.S. households.

• Singles - $200,000 or greater AGI
• Married, filing a separate return - $125,000 or greater AGI
• Couples - $250,000 or greater AGI

The Medicare tax is not a sales tax, nor does it apply to all real estate transactions. Moreover, it’s a tax on investment incomes (which may or may not derive from the sale of a property) and typically won’t include capital gains resulting from the sale of a home, providing that home is a principal residence, and as we stated above, only for individuals or couples with AGIs above their thresholds.

The capital gains tax exclusion rule for sales of a principal residence ($250,000 for individuals, and $500,000 for couples) remains in effect. So, if the profits from the sale of the home don’t exceed these capital gains, they’re not tacked onto the net-investment income tally. Therefore, the 3.8 percent Medicare tax wouldn’t apply.