In 1989, Congress added two additional technical restrictions. First, property located in the United States cannot be exchanged for property outside the United States.
Second, if property received in a like-kind exchange between related people is disposed of within two years after the date of the last transfer, the original exchange will not qualify for non-recognition of gain.
There is an interesting loophole that might be attractive to many owners of rental property. Say you have found your dream retirement house in Florida, or Delaware, or anywhere in the United States, for that matter. If you do a 1031 exchange now, and obtain title to the replacement property where you ultimately want to live when you retire, you can rent out that property until you decide to move. Then, once you have established the new property as your principal residence, if you live in it for at least two years — and more than two years have elapsed since you sold your last principal residence — once again you can exclude up to $250,000 (or $500,000 if married and you file jointly) of the gain you have made.
Although the IRS has given us no guidance as to how long you have to use the replacement property as “investment” property, the general consensus is that you should rent out the property for at least one complete tax year.
Thus, depending on the numbers and the facts, you may ultimately be able to avoid some — or even all — of the capital gains tax which would normally be due when you sold your investment property.
The IRS has also authorized taxpayers to engage in “reverse Starkers,” where you buy the replacement property first and then exchange (sell) the relinquished property. This is much more complex, and you should consult your own legal and tax advisers.
Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel. For a free copy of the booklet “A Guide to Settlement on Your New Home,” send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036.