Tax Deferred 1031 Exchanges

A 1031, tax deferred real estate exchange, also known as a Starker exchange, allows you to rollover the proceeds from the sale of previously owned property into new real estate investments, with the capital gains tax payable being deferred. This has the direct effect of increasing the size of successive investments, since the tax payable is instead added to the investment fund.

This exchange is valid subject to an investor following a few conditions. Namely, that all proceeds from a sale must go into new property acquisition. The property sold must be an ‘investment vehicle’ or one with a productive use, and not your personal residence, or second home. While both the properties sold and purchased must be like kind, it does not necessarily mean that both must be the same type of real estate – i.e. land for land, house for house, shop for shop, etc.

There is no restriction on swapping between these types, and you can also sell one property to fund multiple purchases, which would also qualify as a 1031 exchange. The IRS definition of like kind properties does not include inventory, stocks, bonds, notes, other securities or evidence of indebtedness, or certain other assets. Please refer to the IRS section code 1031 for more details regarding eligibility criteria.

The IRS expressly forbids intermediate use of the funds, in any form, by you, while the rollover of the investment from one property to another is in progress. In order to implement this, the IRS has authorized the use of a qualified intermediary, who will receive and hold the proceeds from the sale, and invest it into new property purchases as per your instructions. After the acquisition, the title of the property will be transferred to your name. The purchase and sale contracts must have specific text which states clearly that the contract is part of a 1031 exchange. At this point, it advisable to engage a real estate lawyer who will be able to draw up the right contracts and facilitate the entire transaction while keeping you in adherence to IRS guidelines.

Important guidelines for 1031 exchanges:

• You have a 45 day rollover period after the sale, to shortlist new investments and send in writing to the intermediary a list of up to three properties for acquisition.
• The new acquisition, or acquisitions, must be completed within 180 days after closure of the initial sale.
• Like kind properties do not include real estate outside the United States
• Partial 1031 exchanges are also allowed. The tax deferral allowed will change accordingly.
• Professional real estate investment consultants provide qualified intermediary services.

The costs, and management fees involved, will vary depending on the services provided and the type of properties being sold and acquired. Please bear in mind that the intermediary is responsible for both holding your funds during the transaction and using it to purchase the new investment, after which the title needs to be transferred into your name. You are advised to stick with trusted consultants and I you are new to this, do your own research to identify and compare the costs and reputation of the intermediary.