If you own property as an investment or as part of a business and want to sell it, a 1031 exchange may be for you. Some people refer to 1031 exchanges as Starker trusts or Starker exchanges. A 1031 exchange can sound complicated, but if you understand how to use a 1031 exchange, it can save you money.
Also, 1031 exchanges can be used for real estate and other investment property, including airplanes and other property held for investment purposes.
1031 exchanges can’t be used when selling your primary residence. When you sell your investment property and don’t use a 1031 exchange, you usually have to pay taxes on the sale. When you don’t use a 1031 exchange, you would be taxed on the gain you realize when you sell the property (the difference between what you paid for the property and what you sold the property for) and also have to pay back any depreciation benefits you received for owning and holding the property.
With a 1031 exchange, you replace the property you owned and sold with a new property of equal value or greater. But you need to generally use a qualified intermediary for a 1031 exchange. A qualified intermediary for a 1031 exchange is a company that specializes in handling 1031 exchange transactions. You need to make sure they are solid and reliable companies before you hire one to help you.
Julianna Clementi-Ryan, a qualified intermediary at Nationwide Exchange Services (http://www.nationwide1031.com/index.html), handles 1031 exchanges on a daily basis. She says, “The taxes that you avoid paying when you do a 1031 exchange are capital gains taxes and depreciation recapture taxes, both on the state and federal level, if things are done correctly.”
In other words, if your property has gone up in value between the time you bought it and the time you’re selling it–if you didn’t use a 1031 exchange, you would pay taxes on the difference in value and in addition pay taxes on the depreciation you previously took on the property.
A 1031 exchange basically serves as an interest-free loan from the government. Keep in mind, even when you do a 1031 exchange, under most circumstances you still have to pay those taxes, you just get to defer them until after you’ve replaced the old property.
Clementi-Ryan says, “You care about the tax deferral because money is worth more now than it is in the future. So why give the government taxes now, when you can postpone doing so?”
To make your 1031 exchange a success, use a qualified intermediary. Make sure the person you hire has experience doing 1031 exchanges. Also, pay attention to the 1031 exchange timeline. The tax year and calendar year aren’t the same for a 1031 exchange. Make sure you know when your 1031 exchange deadlines fall. Also, read the small print. 1031 exchanges have lots of complicated rules, so if you don’t understand what you’re doing, make sure your intermediary explains the 1031 exchange process for you.
July 29, 2008