Anyone selling investment property should consider the advantages of a "Tax Deferred Exchange", in which one property is "exchanged" for another "Like-Kind" property, therefore deferring federal income taxation on the transaction. In some instances the tax can be completely avoided, this is known as "the ultimate exchange".

A tax deferred exchange occurs when one investment property is sold, and another investment property is purchased within a certain time period following the IRC guidelines. This sale and purchase of investment property is converted into an "exchange" by means of an exchange agreement and the services of a qualified intermediary -- the third party that assists in structuring the exchange properly.

The type of real property that investors can exchange is almost unlimited. The IRS has defined "Like-Kind" to include all types of real estate, from an apartment to a beach front condo, to raw investment land, or a single family home. Most any type of real property may be used in a Section 1031 Exchange. Therefore, a motel may be exchanged for a single family home, a vacant lot can be exchanged for an office complex, etc.

How does a typical exchange work?

When an investor sells his investment property, he executes an exchange agreement and appoints a third party to act as the qualified intermediary. When the old investment property is sold, the sale proceeds are paid to the qualified intermediary, who places the sales proceeds into an interest bearing account. Therefore, while the investor is preparing to purchase the new investment property, the investor receives interest on the sales proceeds of the old investment property.

The investor has 45 days to identify the new property he wants to purchase as the replacement property. The closing for the purchase of the new replacement property must occur within 180 days of the sale of the old investment property.

Naturally there are certain restrictions. All of the sale proceeds must be invested in the new replacement investment property, and the amount of the mortgage on the old investment property must be equal to or less than the mortgage on the new replacement investment property. If all the proceeds from the sale of the old investment property are not used to purchase the new property, or if your mortgage is less on the new replacement property than the mortgage on the old investment property then tax will be paid on the difference, which is considered the "gain" or the "boot".

While the basis of the old investment property continues in the new investment property, the investor retains the entire pre-tax proceeds and can purchase a greater value replacement property without increasing his debt or investing more of his own money, which would be required if the transaction was not structured as a Tax Deferred Exchange.

What is an ultimate exchange ?

With the "Ultimate Exchange" , the investor completely avoids the payment of income tax on the investment property's gain. The tax is avoided by combining two IRC provisions: Section 1031 and Section 121. IRC Section 121 provides that a taxpayer may retain gain (i.e. not pay tax) on $250,000 ($500,000 if married) from the sale of a personal residence if the property has been owned and used as their personal residence for at least two of the last five years. From our initial area of discussion we know IRC Section 1031 allows for deferring taxation on gain on investment property.

Today investors are completing the ultimate exchange by moving into their prior Section 1031 Tax Deferred Exchange investment replacement property and complying with IRC Section 121, thereby, completely avoiding paying any tax on the gain. However this can be tricky, the replacement investment property, the subject of the Section 1031 Exchange, must have been used as an investment for at least one year,(preferably two years) prior to moving into the property. After

Since it is not always possible to locate, acquire and take title to new investment properties and conduct an exchange within the 45 day and 180 days after selling your old investment property, a new Reverse Starker Exchange law has been passed that would allow investors to first acquire the replacement investment property and with some strict and complicated procedures, allow them to have greater flexibility in accomplishing this type of transaction.

If you are thinking about selling your investment property, you should obtain expert legal advice on how to successfully structure the Starker and Reverse Starker transactions before you begin any portion of the exchange process.ructuring the exchange properly.

The type of real property that investors can exchange is almost unlimited. The IRS has defined "Like-Kind" to include all types of real estate, from an apartment to a beach front condo, to raw investment land, or a single family home. Most any type of real property may be used in a Section 1031 Exchange. Therefore, a motel may be exchanged for a single family home, a vacant lot can be exchanged for an office complex, etc.

How does a typical exchange work?

When an investor sells his investment property, he executes an exchange agreement and appoints a third party to act as the qualified intermediary. When the old investment property is sold, the sale proceeds are paid to the qualified intermediary, who places the sales proceeds into an interest bearing account. Therefore, while the investor is preparing to purchase the new investment property, the investor receives interest on the sales proceeds of the old investment property.

The investor has 45 days to identify the new property he wants to purchase as the replacement property. The closing for the purchase of the new replacement property must occur within 180 days of the sale of the old investment property.

Naturally there are certain restrictions. All of the sale proceeds must be invested in the new replacement investment property, and the amount of the mortgage on the old investment property must be equal to or less than the mortgage on the new replacement investment property. If all the proceeds from the sale of the old investment property are not used to purchase the new property, or if your mortgage is less on the new replacement property than the mortgage on the old investment property then tax will be paid on the difference, which is considered the "gain" or the "boot".

While the basis of the old investment property continues in the new investment property, the investor retains the entire pre-tax proceeds and can purchase a greater value replacement property without increasing his debt or investing more of his own money, which would be required if the transaction was not structured as a Tax Deferred Exchange.

What is an ultimate exchange ?

With the "Ultimate Exchange" , the investor completely avoids the payment of income tax on the investment property's gain. The tax is avoided by combining two IRC provisions: Section 1031 and Section 121. IRC Section 121 provides that a taxpayer may retain gain (i.e. not pay tax) on $250,000 ($500,000 if married) from the sale of a personal residence if the property has been owned and used as their personal residence for at least two of the last five years. From our initial area of discussion we know IRC Section 1031 allows for deferring taxation on gain on investment property.

Today investors are completing the ultimate exchange by moving into their prior Section 1031 Tax Deferred Exchange investment replacement property and complying with IRC Section 121, thereby, completely avoiding paying any tax on the gain. However this can be tricky, the replacement investment property, the subject of the Section 1031 Exchange, must have been used as an investment for at least one year,(preferably two years) prior to moving into the property. After