By B.K. Haynes
What type of transaction qualifies for a 1031 Tax Deferred Exchange?
Answer: You must exchange real estate for real estate -- (1) house for land (2) farm for shopping center (3) condo for waterfront lot (4) office building for mountain resort (5) cattle ranch for marina (6) apartments for airport, etc. All must be within the U.S.A. and its territories.
How much time is allowed to complete the 1031 exchange?
Answer: You have 45 days to identify the replacement property, or properties, and 180 days (or the due date of your tax return, whichever is shorter) to consummate the exchange.
Who can handle the exchange?
Answer: An exchange Intermediary -- generally an attorney, accountant, or title or escrow officer. Try to locate a professional practitioner to act as an Intermediary, such as a tax attorney or Certified Public Accountant (CPA). Ask if the proposed Intermediary is familiar with tax deferred exchanges and current tax laws.
What is a Starker Exchange?
Answer: This is an exchange where the proceeds from the sale of real estate stay, in theory, on the Intermediary's table until the Seller finds suitable property for the exchange. It is like the exchange is held "in suspension" by the Intermediary. No money or deeds actually change hands between the Buyer and Seller in the initial stage of the exchange. Under the "Starker" ruling, you may have theoretically sold your farm, but you cannot be taxed on your "theoretical" profits if you identify a replacement property within 45 days, and if you fail to complete the exchange within 180 days.
How do I identify properties to be exchanged under the 1031 provision?
Answer: Provide the Intermediary with a "legal" description of the properties to be exchanged, including addresses.
How do I identify property to be exchanged under the Starker ruling?
Answer: Provide the Intermediary with a legal description of the real estate you are selling, and a "general" description of the property for which you would like to exchange. If you've got a Buyer for your farm at, say, a million five, and you want to exchange for a marina; and your Buyer cannot provide a marina at the time of sale, you sell the farm "on paper" to the Buyer, through the Intermediary. When the marina is identified, the Buyer (1) produces the million five (2) tells the Intermediary to buy the marina, and (3) exchanges the marina for the farm. This type of transaction is, in effect, a three-way exchange, between (1) You, the Seller of the farm (2) the Buyer of your farm, and (3) the Seller of the Marina. Three deeds are involved:
How many properties can be identified in an exchange?
Answer: The following guidelines apply to the 1031 rule:
1. If you plan to exchange your real estate for up to three properties, you can do so without any limitation, providing you end up buying one or more of them.
2. If you plan to exchange your real estate for more than three, and up to ten properties, the total value of the identified properties cannot exceed twice the value of the real estate you are giving up in the exchange.
3. If the value of the identified properties (up to three) totals more than twice the value of the real estate you are relinquishing, you must buy 95% or more of the properties you have identified as exchangeable within the process.
Any excess in value received by an exchange participant as a result of a 1031 or Starker exchange is considered "boot" by the IRS and can be taxable under current capital gains guidelines. However, excess value, or "boot", received in the form of an installment note, and transferred through a qualified Intermediary, may not trigger capital gains and could act to further defer the payment of taxes. This is because such excess value is not considered to have been received by the transferee until the installment note has been paid in full, i.e. until the exchange has been completed. This ruling is invalidated when the installment note is secured by cash or a cash equivalent, such as a CD.
What if the Buyer refuses to participate in the exchange?
Answer: Acting under an exchange agreement, the Seller may consider transferring his real estate to a friend, who will be acting as an Intermediary. The friend can then transfer the property to the Buyer who, in turn, transfers (sells) the exchange property to the Buyer. Friend then locates qualified exchange property and transfers it to Seller, enabling the Seller to qualify for tax-deferred treatment. An installment note, transferred as "boot" in this diversionary type of transaction is, however, generally taxed at face value -- as if the note were payment in full of of an obligation by the original intended Buyer to the original intended Seller. Appraisals are usually required to determine relative values associated with exchange transactions. Check with your accountant or CPA.
I am selling my house and want to do an exchange for land. - What should I do first?
Answer: Make sure language is inserted in the sales contract stating the fact that the transaction is part of a 1031 or Starker exchange. Consult with an Intermediary and/or a qualified tax attorney to establish the transaction's conformity with tax laws and to further mark a paper trail for the IRS.
These questions and answers are provided to readers as
general information regarding exchanges. This material is not intended as
legal or other professional advice.
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