Frequently Asked Questions
What type of property qualifies for an exchange?
Any real estate that is being held for productive use in a trade or business or for investment.
What is “like kind?”
All property deemed realty under state law is “like kind.” It is interesting that a taxpayer can exchange land for improved property. Both are considered like kind by the courts. The reason is that no two pieces of real estate are alike. Two identical buildings, next to one another, are not alike because they are on different lots. Property that is specifically NOT like kind property are one’s personal residence and personal property, and are not subject to 1031 treatment. Primary residence exchanges fall under IRC Section 1034.
What is my Basis?
A taxpayer’s basis in a property can be described as: Acquisition price + capital improvements – depreciation taken – partial sales, for example:
Acquisition Price = $400,850
Plus Capital Improvements = $24,666
Minus Depreciation = $122,500
Minus- Partial sales = _____0
Equals Adjusted Cost Basis = $303,016
Each year, as the taxpayer depreciates the property, makes improvements or sells part, the basis changes. To calculate the capital gains tax on a property, do the following:
Say, Sales Price = $500,000
Minus Adjusted Cost basis = $303,016
Equals Capital Gain = $196,984
Multiply this amount by the capital gains tax rate and any state tax to figure your tax liability.
What is a “delayed exchange” (formerly “Starker”)?
Years ago, a taxpayer in the Ninth Circuit named Starker exchanged his timberland to a lumber company and both agreed that when Starker found some property that he wanted, the company would buy it for him. There were actually three different Starker tax cases, with many IRS challenges, and Starker ultimately won all. Out of the several Starker test cases came the present laws regarding delayed exchanges. These were called “Starker’s” for years, but the terminology now used is delayed exchanges.
How does a taxpayer do a delayed exchange?
THE FIRST STEP IS TO GET COMPETENT LEGAL AND TAX ADVICE!
Scenario: A taxpayer wishes to get out of title to his present property, for whatever reason. He/she does not want to pay a capital gains tax, so is advised to make an exchange. Before an acceptable property is found, a ready willing and able buyer appears. If the taxpayer sells, a tax on any gain is owed! If the taxpayer is in actual or constructive receipt of money or other non qualifying property, the transaction will not be for non-recognition under Section 1031. The buyer will not wait long for the taxpayer to find a suitable property. What does the taxpayer do? A delayed exchange! Then, execute an exchange agreement whereby the taxpayer exchanges for a property to be named, hire a qualified intermediary to facilitate the exchange of properties for the taxpayer’s benefit.
What are the rules for a delayed exchange?
Rules in brief:
- Taxpayer must identify a replacement property within 45 days of closing of the disposition to the buyer. The identification must not be vague — use an address or legal description. Taxpayer may identify up to three properties without complications, (the rules allow for more than 3, but see your tax and legal counsel for advice).
- Taxpayer must close on the identified property within 180 days of closing of the disposition property or by the day tax return is due for the year in which the relinquished property was surrendered, (including any extensions), whichever is first.
- If the taxpayer receives no cash, boot (unlike property), or net mortgage relief (occurs when the new loan is less than the old loan), the transaction will be tax deferred…
- To the extent a taxpayer receives any of the above, that portion will be taxable, creating a partially tax deferred exchange. So , one can exchange, defer taxes, and go to another property or properties and continue doing so until death, when the heirs then get a “stepped up basis.”
What is a “Safe Harbor?”
There are four “Safe Harbors” that, if used by the taxpayer, will allow compliance with Section 1031 and provide safety and benefits. They are:
- The fact that the transferee’s exchange obligation may be secured by a mortgage, a standby letter of credit, or a third party guarantee, will not invalidate the exchange.
- A Qualified Exchange Trust.
- A. is not the taxpayer
- B. The trust agreement expressly limits the taxpayers rights to receive or pledge the cash or the equivalent held by the trustee.
- A Qualified Intermediary is a person who:
- A. is not the taxpayer
- B. enters into a written exchange agreement with the taxpayer which requires the intermediary to:
- Acquire the relinquished property from the taxpayer.
- Transfer the relinquished property.
- Acquire the replacement property, and
- Transfer the replacement property to the taxpayer
- Investment Income.
- The taxpayer is entitled to receive interest or a growth factor if taxpayer’s rights are expressly limited.
For additional information, please visit www.irs.gov.