Starker 1031 Exchange
This works sometimes for some owners.
I am an intermediary and not qualified to give out tax, law or
legal advice. Consult with the Internal Revenue Service, a competent
tax attorney or accountant.
There is only one way to sell your
investment or business real estate, such as rental property or
vacant land, without owing tax on your profit. It is a tax-deferred
exchange. Fortunately, Uncle Sam has made it downright easy
to do so, thanks to his Starker delayed tax-deferred exchange
rules. Internal Revenue Code 1031(a)(3) now lets investment and
business property owners sell their old property and then use
the proceeds to buy qualifying replacement property. However,
personal residences are not eligible.
What is a tax-deferred exchange? For
tax purposes, a qualifying tax-deferred real estate exchange
is viewed as one continuous property holding. The major advantage
is that there is no tax erosion of profits while disposing of
one property and acquiring a replacement. For example, I had
a customer that made a tax-deferred exchange of their apartment
building, located about an hour away from their home, to one
15 minutes way. They reinvested all their profits into the acquired
property, so no profit tax was due. More important, their acquired
building offers more profit potential as they fix it up and raise
What is a Starker delayed tax-deferred
exchange? A direct trade of one property for another is no longer
required to qualify for tax-deferral. A delayed trade is called
a Starker delayed tax-deferred exchange (named after T.J. Starker,
the first taxpayer to make such a trade).
Here is how it works: My customer Norris
first sold his old apartment building. He had the sales proceeds
held by a third-party intermediary accommodator. If he had access
to or received the cash, called "constructive receipt,"
his tax-deferred exchange would have failed. After the sale,
Norris had up to 45 days to designate the replacement property
to be acquired. His purchase offer for that property was accepted.
He then told the accommodator to buy the nearby apartment building
with the cash from the sale of his old property. He could have
taken up to 180 days to complete the acquisition. It is that
The top 10 reasons to exchange. Tax
avoidance is the number one reason owners of apartments, rental
houses, stores, warehouses, offices, farms and vacant land held
for investment or business use want to exchange.
Additional reasons include: (2) getting
rid of an undesirable property and acquire a more desirable one;
(3) disposing of a hard-to-sell property and acquiring one that
is easier to sell; (4) changing locations; (5) switching from
one type of property to another; (6) acquiring a property that
requires less management; (7) acquiring a property with better
cash flow; (8) pyramiding ones wealth into a large estate
without paying profit tax when trading up; (9) increasing depreciable
basis; and (10) receiving tax-free mortgage refinance cash either
before or after (but not during) the trade.
The basic exchange rules. There is
no limit to the number of qualifying "like kind" properties
in a tax-deferred exchange. For example, you can trade your two
rental houses for a commercial building. Or you can trade your
warehouse for three rental houses. Remember, your personal residence
cannot be part of a tax-deferred exchange. All properties in
the exchange must be "like kind," meaning held for
investment or use in a trade or business.
The basic exchange rules are: (1) Trade
equal or up in market value; (2) do not take any "boot"
(personal property), such as cash or net mortgage relief out
of the exchange,; and (3) follow the simple tax-deferred exchange
rules, especially for a Starker delayed tax-deferred exchange.
The three types of tax-deferred exchanges.
With slight variations, there are only three types of qualifying
tax-deferred exchanges. One is the direct exchange of one property
for another. This occurs very rarely, because the up-trader usually
wants a larger property, but the down-trader rarely wants the
smaller property the up- trader has to offer.
The second type of exchange is a simultaneous
three-way exchange. This was the first type of exchange I participated
in, almost 12 years ago. I had listed a six-unit apartment building
to someone wanting to move up and exchanged him into an eighteen
unit building. It was tax-deferred for the six unit owner
because he was trading up without taking out any "boot."
But it was taxable for the eighteen unit down-trader, who immediately
sold the six units to a prearranged "stand-by cash buyer"
that I had waiting. Getting three parties all in agreement all
at the same time was the most difficult part!
The third type of tax-deferred exchange
is the Starker delayed exchange. This is, by far, the most popular
type of trade today. It is really a property sale followed by
a property purchase. Just remember to keep the sales proceeds
beyond your "constructive receipt."
A questionable fourth type of exchange,
called the "reverse exchange," has not yet been officially
sanctioned by the IRS, but it does occur. It involves acquisition
of a replacement property (usually by a third-party intermediary)
before the old property is sold.
How to trade your home for income property, or vice
versa. As explained earlier, only property held for investment
or use in a trade or business can qualify for a tax-deferred
exchange. Personal residences are not directly eligible.
However, many owners of investment or business properties
want to make tax-deferred exchanges for a personal residence,
often a luxury home. Or personal residence sellers want to avoid
investment or business property, without paying profit tax. This
cannot be accomplished directly.
One way to achieve this tax-deferred result is to trade
an apartment building for a rental house, following the exchange
rules. The acquired rental house should probably be rented at
least a year before converting it to your personal residence.
Homeowners who would have more than $250,000 in profits
if they sell (or $500,000 for a married couple filing jointly)
can do just the opposite. They can move out, rent their house
most CPAs recommend at least a year and then make
a tax-deferred exchange for investment or business property.
"Tax evasion is illegal.
Tax avoidance is legal and commendable."
Seek qualified advice from a competent tax attorney