Implement a Tax Strategy for Capital Gains

Physician's Money Digest, January 2006, Volume 13, Issue 1

Real estate has been a hot sectorover the past several years.Whether a primary residence,beachfront property, or investment, realestate values have increased dramaticallyin most markets, an upswing in activitythat has the potential to create largecapital gains taxes. The good news isthat with a bit of planning, in manycases you can keep taxes at bay byimplementing a like-kind exchange inwhich you exchange one property for asimilar property. Here are the basics ofwhat you need to know.

Internal Revenue Code Section 1031,which governs like-kind exchanges, suggeststhat a property qualifies for thetax-free exchange as long as both thesold and new property are held for investmentor used in a trade or business.For example, exchanging raw land foran apartment building would qualify.The simultaneous closing and exchangeof these two properties would avoid therecognition of gains by both individuals.Obviously, it would be extremelyrare for there to be an exchangebetween parties of property with equalvalue. In most cases, one party willreceive property and cash while theother party receives just property.

The party buying the real estate usuallydoes not have real estate toexchange and the seller has not identifiedreal estate to use in the exchange.Under this deferred like-kind exchange,the law provides special provisions thatallow the seller time to identify and purchaseproperty owned by a third partythat can be used in the exchange. Forthis transaction, you will likely need theassistance of a qualified real estate attorneywho acts as the intermediary.

Your purchaser agrees to allow youto initiate a Section 1031 exchange andthe qualified intermediary holds yourproperty until the exchange is finalized.Once you transfer property to the intermediary,you have 45 days to identify areplacement property and 180 daysfrom the date of transfer to close theproperty. You can use multiple propertiesfor your replacement property,but there are additional guidelines thatyou must follow in this case. If you failto identify or close on the replacementproperty in a timely manner, your propertywill transfer to your purchaser andyou will owe the taxes on your gains.

One question often asked is: "Can Ido a like-kind exchange with vacationproperty?"Many believe IRS CodeSection 1031 applies, while others suggestit does not. Consult with youraccountant or attorney regarding thisgray area of the law.

, is the founder

of the Welch Group, LLC, which specializes in

providing fee-only wealth management

services to affluent retirees and health care

professionals throughout the United States.

He is the coauthor of J.K. Lasser's New Rules for Estate and

Tax Planning (John Wiley & Sons, Inc; 2001). He welcomes

questions or comments at 800-709-7100 or visit www.welchgroup.com. This article was reprinted with permission

from the Birmingham Post Herald. He thanks his partner

Scott Lee for his assistance with this article.

Stewart H.Welch III, CFP®, AEP