Section 1031 of the Internal Revenue Code, traces its origins back to 1921 and has undergone various changes over the years. Initially introduced in the Revenue Act of 1921 as Section 202(c), it allowed for tax-deferred like-kind exchanges, excluding certain property with readily realizable market value. Subsequent amendments, such as those in the Revenue Acts of 1924 and 1928, refined the provisions, culminating in the Board of Tax Appeals' approval of modern tax-deferred exchanges with Qualified Intermediaries, like 1031 Pros, in 1935.
An Amendment to the Federal Tax Code in 1954 transitioned the reference from Section 112(b)(1) to Section 1031 of the Internal Revenue Code, establishing the contemporary definition and framework for tax-deferred like-kind exchanges. This amendment set the foundation for the structure of such investment real estate transactions as we see today.
The tax court cases, notably including an appellate decision from the 9th Circuit Court of Appeals following the renowned Starker family's tax-deferred like-kind exchange transactions, brought about a profound transformation in the industry. Originating from two delayed exchanges where T.J. Starker and his son Bruce sold timberland to Crown Zellerback, Inc., the litigation challenged the Internal Revenue Service's disallowance of the arrangement, arguing against its qualification for non-recognition treatment. These pivotal decisions established the precedent for contemporary non-simultaneous, delayed tax-deferred like-kind exchanges, showcasing to investors that such investment real estate transactions could indeed qualify for non-recognition treatment, thereby granting sellers greater flexibility in structuring their exchanges. The Starker court case is why you’ll often hear the 1031 exchange being referred to as a Starker Exchange. Some qualified intermediaries actually use the name Starker in their company name, such as Starker Services.
The Tax Reform Act of 1986 played a pivotal role in the amount of tax-deferred like-kind exchange transactions taking place in the market today. By eliminating preferential capital gain treatment and subjecting all gains to ordinary income tax rates, enacting "passive loss" and "at-risk" rules, and replacing accelerated depreciation methods with straight-line depreciation over 39 years for commercial properties and 27.5 years for residential properties, the act significantly curtailed the tax advantages associated with real estate ownership. Consequently, it propelled tax-deferred like-kind exchanges into the spotlight as one of the handful remaining income tax benefits available to real estate investors.
The proposed rules and regulations for tax-deferred like-kind exchanges were issued by the Department of the Treasury, effective July 2, 1990. These proposed guidelines clarified various aspects, including the 45-calendar-day identification period, the 180-calendar-day exchange period, and safe harbor provisions addressing actual and constructive receipt issues. They also reaffirmed that partnership interests do not qualify as like-kind property and provided further clarity on related party rules.
Subsequently, the proposed rules were finalized and became effective on June 10, 1991, with only minor adjustments. These adjustments included further clarification and definition of terms such as "simultaneous exchange" and "improvement exchange," as well as criteria for disqualifying parties from serving as a Qualified Intermediary (Accommodator).
Despite attempts by certain members of Congress or even Presidents to significantly alter Section 1031 of the Internal Revenue Code, such as those made by the Tax Relief Act of 1997, no successful changes have been implemented to date. Various endeavors have been made over the years to amend portions of the 1031 Exchange code and regulations, but the real estate industry has successfully fought off any of those challenges.
The 1031 tax deferred exchange is arguably one of the best reasons to invest in real estate over any other investment. It truly provides investors the leverage to build their portfolios and can be utilized by small investors and large investors alike.
To learn more about how a 1031 exchange can help you grow your real estate portfolio visit www.my1031pros.com or call 916-212-6900 today.
Talk with a live 1031 Pros account executive about how you can utilize a 1031 exchange to avoid taxes on your next investment real estate transaction.
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