A Starker Exchange, also known as a 1031 tax-deferred exchange, is an excellent way a real estate investor can defer the taxes on his capital gains. The exchange allows an investor to sell real estate then use the proceeds to buy another property and not pay the capital gains taxes due immediately. The rules of the Starker Exchange are written in section 1031 of the Internal Revenue Service (IRS) code.
The rules specify that the property sold, also called the relinquished property, and the property bought, also called the replacement property, must be investment properties used for business or investment purposes only. The two properties must be similar or in-kind. For IRS purposes, all real-estate properties are considered in-kind as long as they are for business. For example, a single family home can be exchanged for land and a condominium can be exchanged for a golf course.
The rules of the Starker Exchange also specify that there has to be an actual exchange between the two properties and the replacement property has to be identified 45 days after the closing of the initial property. The proceeds from the sale must be placed in a special escrow account with a qualified intermediary and must all be used to buy the replacement property. Closing on the replacement property has to happen within 180 days of closing of the first property.
The Starker Exchange originated from a series of court cases involving family members of the Starker family. The final case was an appeals case filed by T.J. Starker in the ninth circuit court in 1979. The ruling on this case removed the previous requirement that the exchange of properties be done simultaneously.
If you do a Starker Exchange, you must file a Form 8824 with the IRS for the year in which the exchange takes place. Engaging in a Starker Exchange does not exclude you from paying taxes on your capital gains but simply allows you to defer them. Since the rules and regulations are very complicated, it is always advisable to talk to a financial adviser or an attorney specializing in tax or real estate law.