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.
Managing Partner to Grant Wishes in Louisiana
The attorneys of Simon, Peragine, Smith & Redfearn, L.L.P. have always been committed to the community. Recently, Managing Partner James A. Burton’s community dedication was recognized when he was named to the Board of Directors for the Make-A-Wish Foundation of Louisiana.
In the past, SPSR has adopted a school, donated time and services to nonprofit organizations and designated one week out of the year to raise money for the United Way. Recently, the attorneys strengthened their community efforts by sponsoring a TV public service announcement for the Make-A-Wish Foundation of Louisiana and underwriting National Public Radio on WWNO. The Make-A-Wish spots, which air on WGNO - ABC 26 and feature partner Bruce Shreves, have provided the firm with a new opportunity to realize its responsibility to the community.
“I’m looking forward to continuing the firm’s efforts on behalf of the Make-A-Wish Foundation. With the public service announcement, we were able to reach so many people who would otherwise be ignorant to the important work done by this foundation,” said Burton.
Because Mr. Burton is the former president of Big Brothers Big Sisters of Southeast Louisiana, he is aware of the ordinary challenges facing today’s youth. It is this insight that will only add to his ability to successfully help terminally ill children throughout the state.
In addition to his efforts on behalf of underprivileged youth, Mr. Burton is active in the Louisiana State Bar Association and the New Orleans Bar Association. He also is an Adjunct Assistant Professor at Tulane University School of Medicine. Since 1972, he has been engaged in the private practice of law in Louisiana. Over the years he has cultivated an extensive background in business and tax litigation and administrative proceedings.
The Make-A-Wish Foundation of Louisiana is a nonprofit, volunteer organization whose mission is to grant the wishes of terminally-ill children statewide. Through the ADOPT-A-WISH program, the foundation strives to make dreams into reality with the help of generous corporations, businesses, groups and individuals. The average wish costs $5,000 and ranges from a new puppy to meeting the president.
SPSR Participates in Construction Seminar
On November 10th, partners Bruce Shreves and Denise Puente will aid other attorneys in presenting The Fundamentals of Construction Law. This seminar is co-sponsored by the Louisiana State Bar Association and the Section on Fidelity, Surety and Construction Law, which is chaired by Mr. Shreves.
With the intent of providing attorneys, owners, design professionals, contractors, subcontractors, suppliers, insurers and sureties with a comprehensive and balanced overview of legal issues in Louisiana’s construction industry, The Fundamentals of Construction Law boasts an impressive line-up of speakers. Co-chaired by Mr. Shreves, the seminar’s focus is providing attendees with a sound understanding of these issues and how they relate.
As one of the speakers, Ms. Puente will speak on bid dispute issues, mainly between contractors and state agencies, as well as informing attendees of recent developments in construction law. Further, her presentation will cover procedures for protest on a public bid contract and defects that would require rejection of a bid. Since construction litigation is one of her primary practice areas, she has been in great demand as a speaker. Last January, she provided in-house training for construction contractors, and she made a presentation on issues related to surety in July.
Sixteen other attorneys will round out the seminar with presentations on Business Structures for Construction Companies, Louisiana’s Public Works Act, Drafting Contract Documents, Labor Issues in Construction and Representing the Public Owner in Construction, to name a few. As a popular presenter and the co-author of several books and numerous papers and articles, Mr. Shreves will lend his tremendous experience in the field of construction law to the coordination of the seminar.
The attorneys of Simon, Peragine, Smith & Redfearn, L.L.P. are dedicated to contributing their time, talent and energy to the continued education of their colleagues and those citizens affected by ever-changing laws.
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 www.siia.net.
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