1031 Exchanges, Sometimes Called Starker Exchanges, Offer an Excellent way for real Estate Investors to Defer Taxes and Potentially Lower their Overall Tax Burden, Explains Robert Tweed.
Property markets are hot right now and many real estate investors have done well in recent months. Still, some real estate investors are doing better than others, using sound strategies to empower their businesses. Real estate guru Robert Tweed suggests that investors pay especially close attention to §1031 exchanges, AKA like-kind exchanges or Starker exchanges, which offer a great tax deferral opportunity.
So how does a so-called Starker exchange work? Robert Tweed suggests that you imagine this: You’ve got several investment properties in Los Angeles, which is currently one of the most expensive and hottest markets in the country. Prices are sky high and you’d like to sell one of your properties to raise cash and diversify your investments in markets that aren’t quite as expensive.
Rather than selling your investment property, paying taxes, and then buying another property, you can use a 1031 exchange to swap investment or business properties. (You typically can’t use a 1031 exchange with your personal property, such as a family home.) If the properties are considered “like-kind,” from the POV of the IRS, you can defer paying capital gains taxes.
“Many successful real estate investors have used the 1031 exchange to reduce the burden of taxes,” Robert Tweed says. “And if you follow the rules, you stay on the right side of the IRS. You’re not avoiding taxes, per se, but you are delaying them until you cash out.”
Importantly, “like-kind” in this case is referring to the character and nature of the property, rather than its quality or grade. So, you might trade a 2,000 square foot retailer space in Los Angeles for a 5,000 square foot retail space in Eugene, Oregon, where property prices are lower.
Why are you making the trade? Ultimately, that’s up to you, but you may prefer relocating your investment to another market that offers lower upkeep costs. Or perhaps your family is relocating and you’d like to keep your investments closer to home.
Whatever the case, with a like-kind 1031 exchange, you can make as many swaps as you’d like without having to pay taxes on each swap.
From the Internal Revenue Service’s perspective, when you swap investment properties, you’re not “cashing out” and thus are not obligated to pay capital gains taxes. When you go to sell the property some years down the road, however, you will likely have to pay long-term capital gains taxes. Typically, the capital gains tax costs 15 or 20 percent, although some low-income taxpayers may pay zero percent.
Robert Tweed Explains Why 1031 Transactions Are Also Called Starker Exchanges
These 1031 exchanges go under a few names, and you’ll often hear them referred to as Starker Exchanges. Robert Tweed notes that this is due to court cases involving the Starker Family in Oregon. Throughout complicated legal battles in the 70s, the Starker family argued that they shouldn’t be taxed for real estate exchanges, and ultimately, courts ruled in their favor.
“Many of us real estate investors today owe quite a bit to the Starker family,” Robert Tweed notes. “Their court case provided clarity and added another tool to the real estate investor’s toolbox.”