'Tax-free exchanges' pondered by investors

REAL ESTATE MAILBAG

March 27, 1994|By Michael Gisriel

Q: Several years ago, I purchased an investment townhouse, which I have been renting out. The property has increased in value substantially, and I am considering selling it. But I am afraid that I will have to pay taxes on my profits. I am also considering purchasing another investment property, this time a single-family house. Is there any way to do this and defer taxes on the profits?

A: Today, many real estate investors are considering "tax-free exchanges" to defer taxes on the sale of investment property. Under Section 1031 of the Internal Revenue Code, no gain or loss is recognized on the exchange of property held for investment if such property is exchanged solely for similar property to be held for investment. But the following conditions must be met:

The property to be sold, the townhouse in this case, must be held for business or investment purposes. The property to be bought, the single-family house here, must be of a "like kind." For example, an unimproved lot may be exchanged for a rental building, as they are both real estate, albeit of a different type.

Although there are a number of combinations of transactions that may qualify as a tax-free exchange, the most common is a "Starker" exchange -- a delayed, nonsimultaneous exchange -- named after a series of court cases through which the federal courts sanctioned the practice.

Generally, the Starker exchange consists of the sale of your property, the placing of your sales proceeds in an independent account held by a third party facilitator or trustee, and the subsequent identification and purchase of the new replacement property. The rules require that you identify the new property to be purchased within 45 days from the date of closing on the original investment property. You must close on the new investment property within 180 days after the sale of the original investment property.

There are many steps involved in completing the exchange through a trustee. The inability to properly satisfy one of the technical requirements of Section 1031 may make the entire exchange invalid.

In completing an exchange, it is of the utmost importance that the investor seek the advice of an attorney or accountant.

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