Deferring Capital Gains Taxes Through Delayed Exchanges
By John Shreves

Since 1924, §1031 of the Internal Revenue Code has authorized tax-free exchanges of real and personal property. In 1984, Congress amended §1031 to allow for tax-free, delayed exchanges, or “Starker” exchanges which are named after Starker v. U.S., the case that made them famous, between multiple parties.

A delayed exchange of real property between multiple parties under §1031 allows a taxpayer to sell his investment, rental or business real property and later invest the net proceeds in other real property without, in most cases, paying any capital gains tax. This type of transaction clearly is more flexible and makes the §1031 tax-free exchange available to a wider range of taxpayers.

In a simplified version of a typical delayed exchange:

• the taxpayer sells his property (the “Relinquished Property”) to a buyer for cash
• the buyer transfers the funds into a trust held by a third party (“Qualified Intermediary”) who also will hold the deed to the Relinquished Property
• the selling taxpayer finds an acceptable piece of real property (“Replacement Property”) with a value greater than or equal to the value of the Relinquished Property
• the Qualified Intermediary pays the cash funds held in trust to the seller of the Replacement Property, who, through the Qualified Intermediary, transfers his real property to the taxpayer
• the Qualified Intermediary conveys the Relinquished Property deed to the buyer

The net result is the buyer acquires the property he wants (the Relinquished Property), the seller disposes of his property for cash (the Replacement Property) and the taxpayer owns the Replacement Property without recognizing any capital gains on the transaction.

In order to qualify for a Starker exchange, the taxpayer must satisfy all of the requirements of IRC §1031 and its associated Treasury Regulations. Failure to meet all of the requirements will make the transaction taxable to the taxpayer:

• both the Relinquished Property and the Replacement Property must be held for productive use in a trade or business or for investment by the taxpayer
• the taxpayer must identify the Replacement Property within 45 days of the initial transfer of the Relinquished Property
• • purchase of the Replacement Property must be completed within 180 days of the initial transfer of the Relinquished Property

The fair market value of the Replacement Property must be equal to or greater than the fair market value of the Relinquished Property for complete deferral of the capital gains tax. Further, under the terms of IRC §1031, if the taxpayer receives cash or other property that is not like-kind to the Relinquished Property (in this case, real property), the taxpayer must recognize capital gains to the extent of the other property received. Additionally, specific rules exist under IRC §1031 as to who can and cannot act as the Qualified Intermediary in the transaction, if one is used. Finally, a host of other more obscure rules apply to transactions involving related parties, foreign property, etc.

Although the delayed tax-free exchange of real property under IRC §1031 is fairly simple and straightforward, the taxpayer must comply with all the rules or run the risk of the transaction being currently taxable. Therefore, it is vital for the taxpayer to engage in these transactions only with the advice and guidance of a qualified expert in the tax and real estate area.

John F. Shreves is a general partner in Simon, Peragine, Smith & Redfearn, L.L.P. He is a Board Certified Tax Attorney and a Board Certified Estate Planning and Administration Specialist. Mr. Shreves is also an adjunct professor of law at Loyola University School of Law in New Orleans. Mr. Shreves holds a B.S. and J.D. degree from the University of South Dakota, an M.A.T. degree from Augustana College and an LL.M. in Taxation from the University of Florida, Holland Law Center in Gainesville. He is a member of the New Orleans Estate Planning Council, New Orleans Bar Association, and American Bar Association Section of Taxation, Trust and Probate, and Business Law. Mr. Shreves practices in the areas of estate planning, trusts, successions, taxation, business planning and transactions, franchise and general business law.

Beware the Software Police

While most people are aware of the relative ease in which copies of expensive computer software can be installed on multiple computers or entire networks, they are unaware of laws protecting software publishers from copyright infringement. As recent cases illustrate, a quick introduction to copyright law can prove to be quite expensive and time consuming for the average private citizen or business owner.

Often, after purchasing high-priced software, business owners will attempt to cut corners by giving in to the temptation of copying the software onto the entire network. In other cases, disreputable computer consultants install pirated software onto unsuspecting computer owners’ systems. Either way, installing unlicensed software onto a computer is a violation of copyright law.

The Software Information Industry Association (SIIA), made up of heavy hitting software publishers like Microsoft and IBM, has been monitoring the use of unlicensed software for approximately four years. Originally known as the Software Publishers Association (SPA), this group acts as the “software police” by investigating reports of copyright infringement.

Usually, the SIIA receives reports from disgruntled employees and people engaged in a dispute with a computer consultant. After receiving the initial complaint, the SIIA sends a letter to the alleged offender along with special audit software that can detect pirated software even if it has been deleted. Failure to respond to the SIIA inquiry could result in a business owner being sued in federal court. Those in violation of federal copyright laws face statutory penalties and may have to pay damages related to profits earned using the copied software.

Several precautions can be taken to avoid copyright infringement and its ensuing legal repercussions:

• Only purchase authentic, licensed software
• Establish a written company policy against bootleg or pirated software
• Keep all original software discs/CDs with their original documentation in a secure, central location
• If using a computer consultant, obtain documentation proving the software is original and licensed

Although copying software may seem like a harmless and easy way to save money, it is a serious offense with terribly expensive consequences. To learn more about the SIIA and copyright infringement, visit their website at http://www.siia.net/.