It’s a shame that there are still so many people, including far too many tax and real estate professionals, who are unclear on how Section 1031 like kind tax deferred exchanges work.  One common misconception that I often encounter is that the exchange can only be one for one; dispose of one property and replace it with a single property costing at least as much as the original property’s net price.  That has never been true, and has actually been a very unwise move when working with very expensive properties.  Diversifying by replacing one expensive property with several of lower value is a great way to avoid the classic investing mistake of putting all of one’s eggs in a single basket.  The most replacement properties I can recall in an exchange I worked on was twenty, several years ago when a client sold some Bay Area property and replaced it with 20 homes in Texas.

Which brings up another common misconception; that the replacement property has to be in the same state as the original.  While there are a very few states that may tax exchanges that move equity beyond their borders, that is not true for the IRS.  In fact, more than half of the exchanges that Sherry has been handling for the past 11 years have been between states, and none of them were taxable for Federal or State purposes. 

What triggered these comments was this article from the Wall Street Journal on how an investor replaced one $3.7 million Atlanta property with 33 properties in Florida.  He did run into the biggest problem in working with multiple properties; closing them all within the 180 day statutory replacement period.  He ended up with some taxable gain because some of the properties didn’t make the cut-off.  This is why it’s so important to start working on the replacement process as early as possible, ideally before the disposal leg of the exchange has even been wrapped up.  Too many investors make the big mistake of not even starting to look for their replacement properties until near the end of their 45 day identification period. 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/19/2005 04:03:00 PM Send this post: