CHAPTER 2
 TAX-DEFERRED EXCHANGES

 Tax-Deferred Exchanges Overview

 Realized gains from the sale or exchange of real property must generally be

recognized for federal income purposes (Internal Revenue Code Section 1001(c)). In

general, the realized gain is equal to the net selling price of the property minus the

adjusted tax basis.1 However, under Section 1031 of the IRC, real estate owners who

dispose of their investment, rental, or vacation property and reinvest the net proceeds in

other "like kind" property are able to defer recognition of the capital gain realized on the

sale of the relinquished property.

 It is important to note that a Section 1031 exchange is, strictly speaking, a tax

deferral technique. The taxpayer's basis in the replacement property is set equal to the

transaction price of the replacement property, minus the gain deferred on the disposition

of the relinquished property. Therefore, when (if) the replacement property is

subsequently disposed of in a fully taxable sale, the realized gain will equal the deferred

gain plus any additional taxable gain realized since the acquisition of the replacement

property. However, if the subsequent disposition of the replacement property is also

structured in the form of a Section 1031 exchange, the realized gain can again be

deferred.2


1 The adjusted tax basis is equal to the original cost basis (including the value of the land), plus the cost of
any capital improvements undertaken since acquisition of the property, minus cumulative depreciation.

2 Tax deferral turns into permanent tax savings upon the death of the taxpayer because the basis of the
property is "stepped-up" to its current fair market value. Thus, the taxpayer's heirs can dispose of the