A Starker, or 1031 Tax Exchange ( based on Section 1031 of the U.S. Internal Revenue Code) allows investors to defer taxes on capital gains resulting from the sale of an investment property or properties.
By utilizing the benefits of a Starker Exchange, or 1031 Tax Exchange, an owner may be able to preserve the equity realized in the "sale" property. The main thrust of the Exchange is that the investor Exchanges "like kind property" for "like kind property" and therefore, the Exchange does not generate funds which can be taxed since the profits go directly into the replacement property.
A common assumption is that "like kind" implies house for house, duplex for duplex, apartment building for apartment building, land for land, etc. The actual interpretation of "like kind" is actually much less literal. It defines "like kind" as meaning that both the replacement and the original property must be used as an investment. According to that, any property may be Exchanged with another as long as they are held as an investment, or used in the Exchanger's business.
The Internal Revenue Service's requirements for the Starker or 1031 Tax Exchange are very specific. For example, Exchangers have 45 days from the date of the closing of their sale, to identify up to three properties, and must close on one, or up to three within 180 days. The Sale and Purchase Contract must include verbiage to effectuate the Exchange. At one time, the 45 day "Identification Period" was onerous to sellers.
Now, sellers can choose to participate in a " Reverse Exchange " in which an additional third party called " The Exchange Accommodation Title Holder " ( EAT ), will acquire title to the replacement property until the original property sells. " Reverse Exchanges " shift the 45 and 180 day time periods to the selling side of the transaction.
Another type of Exchange is an " Improvement Exchange ", this allows the " The Exchange Accommodation Title Holder " ( EAT ) to hold the replacement property, while the Exchanger either remodels and improves an existing property, or builds a property from the ground up. Which ever the Exchanger chooses, the project must be complete, and the Exchange take place within the "180 day period."
A recent change in the "Purpose of an Acquistion" may effect the IRS acceptance of the " Tax Deferred Exchange/1031 Exchange , in regards to the exclusion of Capital Gains Tax.
Many clients have completed an Exchange into a rental property that they then convert into a personal residence, planning to resell after the 2 year time period has passed which allows the seller a Capital Gains Exclusion of $250,000 or $500,000. Some Exchangers have done this within only three or four years of the Exchange.
As a result, and a response, written into the recently passed American Jobs Creation Act which President George Bush signed on October 22, 3004, a property acquired in a 1031 Exchange and later converted into a personal residence must be owned for five years from the date of the Exchange before the owner may sell the residence and claim the Capital Gains Exclusion. In order to reap the benefits of a 1031 Tax Exchange , and the Capital Gains Exclusion , the owner must have both used the property as a principal residence for 2 years, and have owned it for at least 5 years.
If you are interested in participating in a Starker, or 1031 Tax Exchange, please consult your Tax Advisor's as well as an Attorney, or CPA who is knowledgeable with 1031 Tax Exchanges. Make sure that the REALTOR® that you have chosen to work with understands the Exchange process, and is familiar with not only the process but also with the specific documentation, verbiage, and time frame requirements as mandated by the Internal Revenue Service.
This article is not intended as any sort of financial or legal advice. This article is only prepared to inform our guests of the opportunity. Please contact one of the Professionals mentioned above, and rest assured, I am quite familiar with The Process, The Timeframes, The Documentation, and The Verbiage. I will be honored to work with you to help you to achieve your goals.
Click here for some great information available to you from the National Association of REALTOR®s (NAR) on 1031 Tax Exchanges.
Click here for Like Kind Exchanges Tax Tips from the Internal Revenue Service.