History of the 1031 Exchange

The first income tax law was enacted in 1918 – and it appears that it didn’t take long for politicians to begin adding loopholes to ease the tax burden for themselves and/or their cronies.

The exchange exemption was added to the tax code in 1921, under Section 202. It stated that there would be no gain or loss on exchanges of “like kind” property. At that time the definition of “like kind” was so narrow that one wonders how anyone ever used it.

If you had a two story brick apartment building you had to exchange it for another two story brick apartment building.

The code section was changed to 112(b)(1) in 1928, and then in 1954 Section 1031 was enacted. Section 1031 stated that: “No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged.”

Thus, in 1954 the definition of “like kind” shifted to something more like “similar.”

In looking at the 1954 tax code it’s clear to see why taxpayers wanted every loophole. The 24 income tax brackets ranged from 20% (for those earning $2,000 or less per year) up to 91% (If you earned $300,000).

But the whole process of finding two people who wanted to exchange was cumbersome. And that difficultly led to the Starker lawsuits – which led to today’s delayed exchanges.

In 1967 the Starkers entered into two similar agreements, one with the Longview Fibre Company and the other with the Crown Zellerbach Corporation
In both transactions the Starkers agreed to transfer timberland to the timber companies in exchange for a promise and credit in the amount of the value of the land transferred. The timber companies promised to acquire property of the same value and transfer it to the Starkers. This was to be done within a period of 5 years or the Starkers would be paid in cash. Both companies did acquire and transfer parcels to the Starkers, and the Starkers subsequently claimed exemption from tax under section 1031.

The IRS said “no way” and the cases went to trial. After two lawsuits were ultimately decided (in favor of the Starkers) by the appeals courts, new regulations approving delayed exchanges were added to the tax code in 1975.

Now it was no longer necessary for two parties to an exchange to be in current ownership of the properties to be exchanged. The Tax Court reversed this ruling in 1977, and the 9th Circuit reinstated it in 1979.

The next big change…

In 1984 Congress amended Section 1031 to allow sellers to place the proceeds of a sale with a qualified intermediary while they themselves identified property to be purchased with those proceeds. New regulations implemented the current 45 day identification period and the 180 day exchange period.

1991 revisions clearly defined “constructive receipt” and set restrictions on the identity of the qualified intermediary as a safe harbor.

In 2002 procedures were revised to clarify TIC (Tenants in Common) interests.

Today, a 1031 Exchange must be completed under the strict IRS guidelines – but it’s worth it.

Want to know more?

Call 619-929-1413 and speak with one of our San Diego real estate investment specialists.

Note* The 1031 Exchange information on this site is meant as an overview and is not to be taken as tax advice. To determine how a 1031 Exchange would affect you, please consult your tax advisor and/or your tax attorney.