What's important about a 1031 exchange is that the capital gains tax on the relinquished property is deferred -- but it does not disappear. What really happens is that the basis for the new property (the "replacement property") is reduced by the adjusted value of the "relinquished property" (the old property).

A 1031 exchange is complex and requires the services of a "qualified intermediary." Among other tasks, a qualified intermediary holds the money from the sale of the relinquished property and applies it to the purchase of the replacement real estate. This must be done because under the rules for 1031 exchanges, the seller of a relinquished property cannot touch money from the sale -- it must be held by the qualified intermediary.

Accounting for a 1031 exchange is also complex. Essentially there is a need to figure out the sale value of the relinquished property, add back depreciation and account for financing. Ed Horan, a well-known exchange authority and the author of How To Do a Like Kind Exchange of Real Estate, has posted a free 13-page exchanging guide with an accounting worksheet that's well worth reviewing before meeting with a tax pro.

Sources and Publications

As always with taxes, nothing is ever simple or easy. Speak with a qualified tax professional for specific advice -- an enrolled agent, a CPA or an attorney who specializes in tax issues.

Also, the IRS itself has excellent information at its website, www.irs.gov, by phone at 1-800-829-1040 and with specialized publications such as those below:

Publication 523, Selling Your Home

Publication 527, Residential Rental Property

Publication 530, Tax Information for First-Time Homeowners

Publication 535, Business Expenses

Publication 587, Business Use of Your Home

Publication 936, Home Mortgage Interest Deduction

Publication 946, How To Depreciate Property

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