Several firms have been established whose principal function is to act as such intermediaries in tax-deferred exchanges. In the simplest form of tax-deferred exchange, the property owner may defer tax on his entire taxable gain, by exchanging his former property for a new property of greater value. He also postpones recapture of depreciation and investment tax credit. This lower basis means that the property owner will get smaller depreciation deductions for his new investment. And, when the property owner eventually sells the property, he will have to report taxable profit on the gain he has realized on both properties.
Many transactions are more complicated than the prior example.
If the exchange is one of mortgaged property for mortgaged property, a net reduction of mortgage indebtedness is treated as boot and will result in taxable gain, although not necessarily in the amount of the mortgage reduction. To qualify for tax deferral, the exchange must be carefully structured, both in order to comply with the time limitations imposed by the Internal Revenue Code, and to avoid actual or constructive receipt of any proceeds of sale. Calculation of the tax effects of a straight sale of the property verses a tax-deferred exchange is essential, since the provisions of IRC Section 1031 are mandatory, not elective, in their application. This complimentary newsletter is intended to provide general information. Because of the complexities and constant changes in the law, it is important to seek professional advice before acting on any of the matters covered herein.