What is a 1031 Exchange?
Internal Revenue Code Section 1031 allows taxpayers to defer the capital gain on the disposition of property held for investment or used in a trade or business. If a company trades in a vehicle or a ball team trades a player, a 1031 exchange is occurring. In the real estate arena, these exchanges are called “Like Kind Exchanges”, “Delayed Exchanges”, “Deferred Exchanges”, and also “Starker Exchanges”. They all refer to a 1031 Exchange.
If a taxpayer intends to acquire replacement property, the tax savings possible through an exchange can be quite significant. Property owners should always consult their tax adviser prior to entering into a real estate transaction so they can plan in advance for the consequences that they desire.
There are three types of real estate 1031 exchanges that can occur:
Simultaneous Exchanges are where the relinquished property is transferred at the same time as the replacement property is received. With the exception of a direct trade between two property holders, a third party is needed in the transaction to facilitate the acquisition or sale of one of the properties and then completion of the exchange.
Delayed, Deferred, or "Starker" Exchanges are where the relinquished property is transferred prior to the time the replacement property is received. This trans-action requires use of a third party to sell and buy the properties involved, and to hold the proceeds from the sale of the relinquished property.
Reverse Exchanges are where the replacement property is acquired by a third party for the taxpayer prior to the time a sale has been arranged for the relinquished property. At some point in the transaction, the replacement property is simultaneously exchanged for the relinquished property, which is sold by the third party.
The third party referred to in these transactions is known as an intermediary or facilitator. That entity cannot be related to the exchanger as outlined in the Internal Revenue Service regulations, or the validity of the exchange is at risk. A professional real estate intermediary will provide the best service at a reasonable cost, and can work with the exchanger’s real estate and tax professionals to see that the desired results are achieved.
Information created by:
Marin County Exchange Corporation
David M. Hellman, Pres., Attorney & CPA