If you own rental property and want to sell it without incurring significant taxes, you may want to consider a 1031 exchange, named for part of the tax code. 1031 exchanges are sometimes referred to as Starker trusts or Starker exchanges.

Once you’ve decided to do a 1031 exchange, there are a few steps to follow to make sure the 1031 process runs smoothly. The first step in a 1031 exchange is finding a good, solid and reputable qualified intermediary to handle your exchange.

In a 1031 exchange, the qualified intermediary acts on your behalf and in some cases ends up holding the proceeds from your sale for almost six months. You want to make sure your money is safe when held by the qualified intermediary during a 1031 exchange.

“When you’re doing a 1031 exchange, it’s like driving, if you look the wrong way, you could crash,” says Julianna Clementi-Ryan, a qualified intermediary at Nationwide Exchange Services (http://www.nationwide1031.com/) in Chicago. “And it’s the same thing with a 1031 exchange, and that’s why you have a 1031 intermediary company who’s basically driving the car for you on cruise control.”

Once you decide to sell your property and do a 1031 exchange, you have to follow a 1031 exchange identification period. You have 45 days after you sell the original property to turn in a written list of up to three new properties you plan to pursue as part of the 1031 exchange. In some cases, you can designate more than three properties during a 1031 exchange, but other rules and restrictions will apply to that transaction.

For a 1031 exchange to work, the new properties have to be like-kind properties, meaning they’re of similar purpose and value: a piece of real estate for another piece of real estate or an airplane for an airplane.

In a 1031 exchange, you have 180 days from the day you sold your old property to purchase the new property. In some cases, you might have less than 180 days to purchase the replacement property, principally if you sell your existing property close to the end of a calendar year. You should talk to your 1031 exchange intermediary further on this issue.

During this period of your 1031 exchange, you can’t receive any of the money from the sale of the old property. For a 1031 exchange to work, your intermediary has to hold all of the proceeds from the sale of your property.

A 1031 allows you to defer taxes, but in most cases not get out of them entirely. Clementi-Ryan 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.”
The most important part of a 1031 exchange is the timing. Make sure you go over the time frame for each step of the 1031 exchange process with your qualified intermediary, and remember; your tax year and a calendar year may run on different schedules and can affect you in different ways when you are contemplating a 1031 exchange.

July 29, 2008