Q: I’m receiving proceeds from the sale of commercial land which will generate $132,000 in capital gains.
I rejected the 1031 method to defer the gains tax simply because it is just that, a deferment. I also don’t like to be at the mercy of whoever else is involved in the tenant-in-common property and the difficulty in investing in rental property in such a short span of time allowed.
Am I required to pay the tax to the IRS now, or can I declare it on my return next year?
A: To defer the payment of taxes on the sale of commercial property, there are two types of tax free exchange mechanisms that you can use. Both involve Section 1031 of the Internal Revenue Code and they are sometimes referred to as Starker Trusts or Exchanges.
For simplicity purposes, a seller of an investment piece of income-producing real estate can sell the property and buy another of equal or higher value and defer the payment of taxes to the Federal government.
Upon the sale of the old property, the owner has 45 days to find a new property and designate that property as the replacement property. The seller then generally has 180 days to buy a new income-producing piece of real estate.
There are other cumbersome rules, but if the rules are followed correctly, an owner of real estate can buy and sell real estate for many years without paying taxes on the gains that are made and without paying tax on the depreciation benefits obtained during the many years that the properties were owned.
Tax-free exchanges cannot be used to defer the payment of taxes when money is made on the sale of real estate that is not held for income-producing purposes. And, it can’t be used when real estate is bought and sold repeatedly in a similar fashion to stocks in the stock markets.
Your question is puzzling because you made a reference to the term “tenants in common”. Some companies now specialize in locating properties that can be used in 1031 exchanges by selling them a piece of a property that would be held by that person along with many others. If you can’t find a property to buy on your own and need a place to put the proceeds from the sale of a property you had and don’t want to pay taxes on the gains, these companies offer an alternative.
The property these companies may want to sell you for your replacement property may be a single tenant property where the tenant has great credit and is unlikely to ever miss a rent payment. In addition, that tenant has the obligation to maintain the property and the landlord has little risk when it comes to the property. Thus, if you invested in this property, you would invest with many others and become a co-owner in common with all the others.
If you don’t want to buy a replacement property and don’t want to invest with others, then once you close on your sale you will have a large tax liability. The tax liability must be paid when you file the tax return for the year in which you sold the property. In your case, if you sold the property in 2005, you would pay the taxes in 2006.
Published: May 13, 2005