Uncle Sam's Generous Gift
To Real Estate Investors
What Is A §1031 Exchange?
A §1031 Exchange (sometimes called a Starker Exchange) refers to Section 1031 of the Internal Revenue Code and it offers real estate investors an excellent opportunity to build wealth while saving taxes. By completing a §1031 Exchange an investor can dispose of one investment property, use all of the equity to acquire a different investment property, defer (not avoid) the payment of capital gains & "depreciation recapture" taxes and leverage all of the equity from the original property into the replacement property. The end result is that you "sell" one property, "purchase" a replacement property and defer payment of federal taxes that would have been due on the sale of the initial property.
A Quick Overview Of The Process
The process is slightly complex and only careful compliance with IRS regulations and procedures will guarantee your qualifying for the tax benefits of a §1031 exchange.
Some basic requirements are:
The original investment property is called the relinquished property and the new investment property is called the replacement property. When ownership of the relinquished property is transferred to the new owner, the net proceeds are placed in escrow with a qualified intermediary (a person or entity not related to the exchanger). The investor then has 45 days from the date of closing on the relinquished property, to identify the replacement property (or properties) and 180 days from the date of closing to actually take title to the replacement property.
For tax computation purposes, the tax basis of the old property becomes the tax basis of the new property. Thus, when you ultimately sell the replacement property, your tax accountant (and the IRS) will compute your gain as the difference between your original tax basis plus any improvements) and the sale price. In other words, the profit (gain) you deferred declaring as a result of the §1031 Exchange will ultimately be taxed when you sell the replacement property
Words Of Caution:
The §1031 Exchange is definitely a valuable tax shelter but the question remains, why would anyone want to exchange properties in the first place?
Note: This article is not intended as legal or accounting advice.
Before making any decisions, seek the advice of an attorney and/or accountant.
© Copyright 2007 Bill Boeckelman Publications