1031 exchanges are named after section 1031 of the Internal Revenue Code. The purpose of a 1031 exchange is to defer capital gains tax. This is accomplished through exchanging certain kinds of property in a process known as a 1031 exchange.
In 1979, the laws around 1031 exchanges loosened to allow exchanges involving the non-simultaneous sale and transfer of real estate. This updated set of rules became known as the Starker exchange. Nearly 40 years later, President Trump’s Tax Cuts and Jobs Act of 2017 repealed the Starker exchange for all kinds of property except real estate.
Today, the 1031 exchange is colloquially known as the “like-kind” exchange or simply the “Starker,” so called for the Starker exchange. By whichever name, a 1031 exchange is a swap of one investment property for another. Such an exchange is typically undertaken to reduce the tax liability of the person making the exchange.
By making the swap of one investment property to another, one can change the form of an investment without recognizing a so-called capital gain or cashing out. The idea is to allow the investment to grow in a tax-deferred manner. The beauty of a section 1031 exchange is that it sidesteps capital gains and can be done in an unlimited fashion.
An investor may transfer the gains from one real estate investment to another real estate investment endlessly. As far as the IRS is concerned, there is no tax bill due until you decide to cash out because the property has been continually swapped.
Once you do decide to cash out, perhaps at the denouement or a long string of real estate property swaps, the investor can expect to pay only one tax at a manageable rate. The so-called long-term capital gain rate is usually around 15 percent, and the tax liability could literally be nothing for certain income brackets and real estate investments.
The wonderful thing about section 1031 exchanges is that they can severely reduce one’s tax liability, and section 1031 exchanges can apply to a surprising array of investments. One may transfer, for instance, a strip mall for an apartment building for a ranch. A business associated with a property may also be swapped for another property.