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The Delayed or Deferred Exchange
The delayed exchange is the most frequently used type of exchange
and is specifically authorized by statutory amendment (Tax Reform
Act of 1984). These exchanges are often referred to as "Starker"
exchanges (after the name of the litigant whose case determined
the tax law). Timing is critical: the replacement property must
be identified and acquired within a statutory time period commencing
with the close of escrow of the relinquished property.
The requirements to complete a successful tax-deferred exchange
include the following:
Each parcel of real property involved in the exchange must
be held for investment or for use in a trade or business.
The replacement property must be "like kind" property.
The definition of "like kind" at this point is broad.
One may, for instance, exchange between improved and unimproved
real estate, and between residential and commercial property.
However, personal property may not be exchanged for real property.
Nor may foreign real property be exchanged for domestic property.
Timing is paramount: The replacement property or properties
must be properly identified no later than 45 calendar
days and must close no later than 180 days
following the close of escrow for the sale of the exchanger's
Phase I property (the relinquished property). The 180 days may
be shortened where the Phase I closing occurs between October
15 and December 31, unless the taxpayer files a timely extension
with the IRS by April 15th of the following year.
In order to defer recognition of all gain, the exchanger must
acquire replacement property that:
is equal to, or greater than, the net sales price of the relinquished
property, and
uses an equity amount that is equal to or greater than the equity
from the sale of the relinquished property as the down payment
on the replacement property.
The exchanger may choose to receive a portion of his or her
equity at the close of escrow on the sale of the Phase I relinquished
property without jeopardizing the exchange. However, the equity
received will be taxable. Certain items such as prorated interest,
property taxes, insurance, and rent are considered operating
expenses reported on Schedule E of the exchanger's tax return.
If sales proceeds are used to pay these expenses in escrow,
the amount used will be considered "Boot" or Taxable
Gain. The net effect is neutral since these expenses are deductible.
Sales proceeds used to transfer tenant security or rent deposits
to the buyer are considered "Boot" or taxable gain
without an offsetting deduction. Exchangers may pay for these
non-sales cost items by making a separate deposit into the escrow
to eliminate the problem.
Although the specific requirements are stringent, considerable
flexibility is available in the exchange process. For example,
the exchanger may exchange one investment property for several,
or conversely, may consolidate several investment properties
by replacing them with one property.
In certain co-tenancy situations, one owner may select a Section
1031 tax deferred exchange, while another owner may opt to sell
his or her interest in the property, or exchange into another
property separately. A single piece of real estate may be allocated
between personal and investment use. For instance, the exchanger
may own a duplex and live in one unit and rent the other. The
percentage value of each will be reflected in the replacement
property or properties.
Although a shareholder interest in a partnership,
corporation, or trust may not be exchanged, the entity itself
may exchange property under Section 1031.
Delayed or Deferred Exchange
Simultaneous Exchange
Reverse Exchange
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