What is a Starker 1031 Tax-Deferred Exchange?

• Starker 1031 tax-deferred exchanges are the best known and most common tax-deferral tool for real estate: it’s an exchange of property and tax deferral under the provisions of IRS Code section 1031. 
• A 1031 exchange allows the complete and indefinite deferral of capital gains taxes and recapture of depreciation, allowing taxpayers to do the following:

1. Trade up to larger investment properties.
2. Relocate real estate investments.
3. Change the type or character of real estate investments.
4. Diversify or consolidate real estate investments to or from multiple properties.
5. Trade nonproductive property for real estate investments that produce income.

• The 1031 exchanges sprang from a 1979 court decision that allowed property owners to sell one property and wait up to six months to buy another without losing the right to consider the transaction an exchange for tax-deferral purposes.
• That case opened up a whole new profession in the real estate industry: the qualified intermediary or accommodator.  Their job is to facilitate and document 1031 exchanges by receiving the proceeds of a sale under the terms of an exchange agreement and then applying those funds at the direction of the exchanger for the acquisition of the replacement property.
• 1031 exchanges usually happen with little effort on the part of the buyer and seller.  Instead, the qualified intermediary or accommodator handles the paperwork and then sends it to escrow/title companies or closing agents to the buyer and seller of each property for signatures.
• This is how the process goes if you’re the seller/exchanger:

1. List your property with an agent, making sure he or she knows you plan a 1031 exchange.
2. When you get an offer, your agent will include a counteroffer provision that states the “buyer agrees to cooperate with seller’s 1031 exchange.”
3. Open escrow, and then choose your accommodator.
4. Sign an exchange agreement with your accommodator through escrow along with the other customary escrow paperwork.
5. At the close of escrow, your proceeds will be transferred to your accommodator’s trust fund on your behalf and held there until you begin the process of buying your replacement property. 

• Here’s how the process goes to purchase the replacement property:

1. Identify the potential replacement properties following IRS rules.
2. Negotiate a purchase agreement, including a provision that the seller will cooperate with the 1031 exchange.
3. Open escrow and have the purchase contract earnest money deposit transferred from the accommodator’s trust fund to the escrow or closing agent’s account.
4. Continue the purchase process normally, doing inspections, arranging financing, and so on.
5. At closing, the accommodator transfers the balance of the exchange funds to the escrow or closing agent, who then closes the transaction.

Disclaimer: This article is provided for information use only.  It does not take the place of an attorney, a tax advisor, or an accountant.  Always seek out the advice of a licensed professional before undertaking any significant change in your financial situation.