Summary: A reader is selling commercial land
and making a large amount of money in capital gains. Sam and Ilyce fully explain
the 1031 - Starker Trust and the laws regarding capital gains tax payments.
Q: I’m receiving proceeds from the sale of commercial land which will
generate $132,000 in capital gains.
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I rejected the 1031 method to defer the gains tax simply because it is just
that, a deferment. I also don’t like to be at the mercy of whoever else
is involved in the tenant-in-common property and the difficulty in investing
in rental property in such a short span of time allowed.
Am I required to pay the tax to the IRS now, or can I declare it on my return
A: To defer the payment of taxes on the sale of commercial property, there
are two types of tax free exchange mechanisms that you can use. Both involve
Section 1031 of the Internal Revenue Code and they are sometimes referred to
as Starker Trusts or Exchanges.
For simplicity purposes, a seller of an investment piece of income-producing
real estate can sell the property and buy another of equal or higher value and
defer the payment of taxes to the Federal government.
Upon the sale of the old property, the owner has 45 days to find a new property
and designate that property as the replacement property. The seller then generally
has 180 days to buy a new income-producing piece of real estate.
There are other cumbersome rules, but if the rules are followed correctly,
an owner of real estate can buy and sell real estate for many years without
paying taxes on the gains that are made and without paying tax on the depreciation
benefits obtained during the many years that the properties were owned.
Tax-free exchanges cannot be used to defer the payment of taxes when money
is made on the sale of real estate that is not held for income-producing purposes.
And, it can’t be used when real estate is bought and sold repeatedly in
a similar fashion to stocks in the stock markets.
Your question is puzzling because you made a reference to the term “tenants
in common”. Some companies now specialize in locating properties that
can be used in 1031 exchanges by selling them a piece of a property that would
be held by that person along with many others. If you can’t find a property
to buy on your own and need a place to put the proceeds from the sale of a property
you had and don’t want to pay taxes on the gains, these companies offer
The property these companies may want to sell you for your replacement property
may be a single tenant property where the tenant has great credit and is unlikely
to ever miss a rent payment. In addition, that tenant has the obligation to
maintain the property and the landlord has little risk when it comes to the
property. Thus, if you invested in this property, you would invest with many
others and become a co-owner in common with all the others.
If you don’t want to buy a replacement property and don’t want
to invest with others, then once you close on your sale you will have a large
tax liability. The tax liability must be paid when you file the tax return for
the year in which you sold the property. In your case, if you sold the property
in 2005, you would pay the taxes in 2006.
Samuel J. Tamkin is a Chicago-based real estate attorney. Ilyce
R. Glink’s latest book is 50 Simple Steps You Can Take To Sell Your
Home Faster and For More Money In Any Market. If you have questions for
them, write: Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022
or contact them through Ilyce’s website www.thinkglink.com