Expert shares tips for mastering 1031 exchanges

WASHINGTON – Nov. 26, 2007 – Why bother becoming an expert on 1031 exchanges? For starters, using a like-kind exchange instead of selling the property outright will almost certainly save your seller big bucks in taxes, says Jim Miller, vice president and southwest regional manager of IPX 1031 in Phoenix.

In addition, 1031 exchanges are a great estate-planning tool because heirs can receive a stepped-up basis and have any deferred taxes on the property forgiven by the Internal Revenue Service.

But be careful that you don’t try to count the sofa as part of the relinquished property’s value, Miller told a group attending the Realtors® Land Institute class on 1031 exchanges during the recent 2007 Realtors Conference & Expo in Las Vegas.

As the name implies, like-kind exchanges must be of similar property, so a sofa or other furnishings in a condo held for investment and rented out couldn’t be counted as part of the property value when it’s exchanged since furnishings are personal property.

“If the personal property is valuable enough, you can do a separate exchange for other personal property, but if it’s just a small amount, take the value of the furnishings as a boot and pay the taxes on it,” Miller said. “It probably isn’t worth paying an attorney to do a second exchange.”

What’s the boot?

The term “boot” refers to any non-like-kind property that is exchanged, Miller said. Boot, which is most often in the form of cash, can result when the value of the piece of real property being relinquished is greater than the value being acquired.

“Receiving a boot in a like-kind exchanges doesn’t disqualify the exchange, it only introduces a taxable gain to the transaction,” Miller said. Only the gain that results from cash and unlike property is taxable.

These amounts cannot exceed the amount of the gain recognized if the property was sold in a taxable transaction.

How to calculate the gain

To calculate taxable gain, a property seller should begin with the price of the relinquished property and then subtract the adjusted basis of the property. This amount is the realized gain.

The adjusted basis is the purchase price of the relinquished property plus any capital improvements to the property, less any depreciation. The basis amount carries over to become the basis of the replacement property.

While 1031 exchanges cannot be used for residential property that is used as a primary residence or a vacation home that is used by the owners for more than 14 days per year, it provides a great strategy for deferring taxes on highly depreciated properties.

Source: REALTOR® Magazine Online

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