By LISA SCONTRAS
Custom Publishing Group

The downside to the unprecedented appreciation of real estate investments in Hawaii is when the IRS knocks on your door to collect a hefty chunk of your cashed-out equity in the form of capital gains tax.

No one likes writing checks to Uncle Sam, and there is a simple way to avoid it, or at least to defer it. It's called a 1031 exchange.

The 1031 exchange is named after section 1031 of the IRS tax code. According to Julie Tumbaga, vice president and regional manager of OREXCO 1031 Exchange — a leading exchange facilitator and consultant — this tax code allows a property owner to defer payment of capital gains tax arising from the sale of property, if the proceeds are reinvested in a property of like kind.

The definition of "like kind" is any property held for investment, including rental houses, raw land, business property commercial real estate, condos and apartments.

"Although there are many complex details in the 1031 exchange process," says Tumbaga, "it basically works like this: The taxpayer is required — within 45 days of closing his sale — to identify in writing the intended potential replacement property. The purchase of the replacement property must be completed within 180 days of the sale."

Exchanging or trading property is gaining popularity among investors who don't want to sell, but want to move their real estate holdings around.

"It can be a way of relieving a property owner of the burden of a high-maintenance property or difficult renters," says Tumbaga. "It allows for diversification of a property owner's portfolio, and it allows a property owner to replace non-income-producing property with income-producing property — for example, exchanging vacant land for a rental property."

Dan Kaslow, Realtor at Prudential Locations LLC, says that trading properties is a concept that is really taking hold, particularly on the Mainland.

"Many investors in California, for instance, are looking to trade their inland property (in California) for an oceanfront property here with very little or no additional funds required," says Kaslow, who sold more than 60 units last year and assisted many clients in meeting their tax goals by exchanging properties. "That's very appealing to them. It's worthwhile to utilize a 1031 exchange program if you are going to have a very high capital gains that will affect your tax bracket negatively in that specific fiscal year."

Investors also find it appealing that they can sell one property and replace it with multiple properties.

Tumbaga says that investors shouldn't be intimidated about exchanging properties. The biggest misunderstanding about the process is related to how much needs to be reinvested — you need to reinvest the entire sales price — the total of what you originally paid for the property you're trading, plus the gain.

"Exchanges are not complicated," says Kaslow. "Most quality title and escrow companies have a 1031 program facilitator at a reasonable fee, or an expert in their office to assist you in the process."

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