The Section 1031 Exchange of Internal Revenue Service (IRS), also known as Starker Exchange or Tax-Deferred Exchange, clearly states that there are no gains and losses incur on exchange of like-kind property. Without gains or losses, the exchange of property defers the tax. Like-kind property means same nature or character. And, the property for exchange must be used for business or investment purpose in order to qualify.
The qualified property includes apartments, rental houses, retail properties, commercial, raw land, office buildings, industrial, and ranches. The non-qualified property includes personal residences, dealer properties, partnerships interests, inventory, stocks, bonds, notes, securities, indebtedness, and other properties.
IRS also permits to mix and match the nature or character property. For example, you can trade an apartment for rental house. And, IRS gives the owner of the property forty days to produce a list of possible trades, and one hundred eighty days to complete the exchange of property.
The owner can also exchange two, three, or more property for one property. The general rule is the replacement property exceeds or matches the value and debt of the property being exchanged. For example, a raw land which is worth $600,000 can be exchange for $300,000 rental houses, and $300,000 retail properties.
There are a number of reasons to exchange a property. The common reasons for exchange are rebuilding equity, moving investment location, upgrading size, reducing maintenance expenses, and maximizing the appreciation.
First, the owner proceeds with the regular sale of property. After the completion of purchase and sale agreement, the owner takes the agreement and notifies of 1031 exchange to closing agent. Then, the Qualified Intermediary (QI) who handles the exchange gets the information to closing agent, and sets up the proper papers for exchange. Within forty days, the owner writes and gives a list of replacement property to the QI. In one hundred eighty days, the owner signs the completion of purchase and sale agreement with 1031 Exchange Clause of the replacement property. Finally, the QI contacts the closing agent on replacement property to complete the 1031 Exchange.
The Real Estate Exchange effectively and efficiently reduces the tax. Failing to meet the requirement, the owner pays a hefty tax on capital gains. The QI makes sure that the owner qualifies for the exchange. Most QI composes a team of CPA and Attorney.