A tricky and esoteric realty transaction commonly called a "1031 exchange" demands professional attention beyond that found in a typical home-for-sale transaction.

Named for Internal Revenue Code Title 26, Section 1031 the transaction is an exchange of a business or investment property for a similar or "like-kind" property. A like-kind property is a property of the same nature or character. The transaction is designed to allow investors to defer capital gains taxes.

An example, says Marie Sternberger, an enrolled agent in Sunnyvale, CA, is exchanging a rental duplex for an apartment building.

There can be no profit or loss recognized if the business or investment property is exchanged solely for like-kind property and any cash, or "boot," that is received is taxed, Sternberger says.

"Exchanges are complex and require the help of a tax professional who can determine your tax implications", says Scott Mitchener, an agent with Gabilan Properties in Gilroy, CA, but they can come in handy.

Such as:

• When a property has no more depreciation to write off, you can exchange it for another investment property and begin depreciating the new property.
• You can use an exchange to combine the equity of two or more properties into one larger investment, hopefully with more returns.
• You can also use an exchange to relocate, because you want different scenery or perhaps because the scenery comes with a market that's appreciating faster.

"Where a market is hotter, yes. Also, people relocate or retire to new areas. They can exchange to the new area to be close to their new investment property," Mitchener said.

Generally, to complete the deal, an exchanger, say a title company's exchange department or an exchange company, lists the property to be exchanged with a real estate broker who lists the property as an exchange property.

When a buyer bites and the property sells, the bank funds the buyer's loan. The exchange property seller does not take possession of the funds, which go instead to the exchanger, who releases it to the seller of newly acquired property.

After closing escrow for the sale of the initial property, the exchanger has 45 days from day after close of escrow to locate an exchange property and 180 days to close escrow on the deal. Any remaining boot is taxed.

The use of both a real estate agent, exchanger, two escrows, the possibility of taxable boot if the deal isn't handled just so, and other esoteric details make professional advice virtually mandatory for exchanges.

Exchange resources

• Exchange Information Network
• 1031 Clearinghouse
• National Exchange Services, Inc.
• Starker Services, Inc.
• Starker Services, Inc.'s exchange savings calculator

Published: May 28, 1999

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