If you are a real estate investor, then you more than likely plan to do some buying or selling of investment properties this year. However, with the current capital gains tax rate, those who are looking to sell a house may wish to consider a Starker exchange instead.
A Starker exchange essentially allows you to defer your tax obligations by exchanging properties with another. The specific and complex rules are outlined in Section 1031 of the Internal Revenue Code. For investors, this option allows you to take your investment property that you are looking to sell, and exchange it for another investment property while deferring taxes.
Currently, the capital gains taxes are a hefty 18.8% —not including a recapture tax on depreciation.
The rules are rather complex, but a basic synthesis of the rules is explained below. Please note that you should thoroughly review these rules yourself and make sure you follow them to deter taxes.
Properties must be exchanged
The replacement property (the one you receive) has to be “held for productive use in trade, in business, or for investment.”
Property cannot be your principal residence
There are detailed rules that outlines how soon a replacement property must be identified after transferring your property to its new owner as well as the number of properties that can be exchanged and their aggregate fair market value.
It is essential to note that the property or properties you obtain are to be used for investment property purposes (at least for a while) and therefore are to be rented out to tenants. If you do not wish to be a landlord, you can always hire a property manager to do everything from tenant screening to collecting and depositing rent checks for you—allowing you to continue focusing on finding new investment properties.
In short, if you are looking to sell an investment property this year but wish to avoid the 18.8% capital gains tax, then you should look into a Starker exchange and determine if this option is a good fit for your investing goals. Make sure you speak with a financial advisor to ensure that a Starker exchange is a good idea for your specific circumstance.
Matthew is the CEO of Evernest. He is a student of the book Good to Great and is passionate about building the best property management company on the planet (and maybe even the universe if Elon Musk will hurry up). You can usually find Matthew at the baseball field with his son, at a dance recital with his daughter, or at his favorite restaurant with his wife, when he’s not in the office. And if you can’t find him in any of those places, it probably means he’s traveling.