1031 Exchange Services, LLC

The History of Exchanges

Exchanges have been around for thousands of years and are based on the old barter system. ("I will give you X, if you give me Y.") In the early 20th century, the United States Tax Code came into existence.

The IRS held early on that if two parties swapped property and created no cash, the tax consequences could be carried forward into the new property. (Certain cash, mortgage and other details have to be considered.) Because taxes have to be paid in cash, and in a pure swap no cash is created, it was deemed unreasonable to force taxpayers to liquidate assets to pay any taxes due.

In more recent years, four events have further defined and advanced the use of tax-deferred exchanges:

THE STARKER RULING ¹
This 1979 landmark court decision set the precedent allowing exchanges to be done on a delayed basis. The Starker family owned property in the state of Oregon. A corporation, Crown Zellerbach, offered to purchase the Starker family's property. They had a very low basis in the property, and if they sold it, would have a very high tax consequence. Crown Zellerbach needed to close on the property quickly. In order to satisfy the buyer, the Starker family agreed to sell the property quickly, but structured the sale as a delayed exchange.

At the closing, instead of giving the Starker family cash, Crown Zellerbach gave the Starker family a pledge to acquire future identified properties that they would deed to them in the future. It took several years for the Starker family to identify properties for Crown Zellerbach to acquire and deed to them. The IRS eventually audited the Starker family's return and disallowed the exchange. Although the Starker family paid the taxes, they filed a claim against the IRS. Ultimately, the courts issued a series of three different rulings with a final ruling in favor of the Starker family. The court held that the Starkers had complied with the exchange rules, even though they had done it on a delayed basis.

1984 IRS REGULATIONS
These regulations refined the Starker ruling. In order to be more specific on timing, the IRS codified the time frames they would allow on delayed exchanges. In 1984, Section 1031 was amended with these delayed time frames added.

These regulations allowed for the replacement property to be identified within 45 days from the disposition of the relinquished property and the replacement property to be acquired within 180 days or the date of the next tax reporting period, whichever comes first.

THE TAX REFORM ACT OF 1986
The Tax Reform Act of 1986 eliminated any special capital gains tax treatment and thus made exchanging more financially advantageous. This act made capital gains taxable at ordinary income rates. This effectively moved the tax rate on capital gains from 20% to 28%, thus making tax-deferred exchanging more attractive because of the potential tax savings. (As of the last website update, the capital gains tax rate has been reduced to 20%.)

1991 IRS REGULATIONS
In April 1991, the IRS issued a major revision of Section 1031. Prior to 1991, certain steps of the exchange process were not clearly defined. The new regulations clarified who could act as an intermediary, how replacement properties were to be identified, and approved the direct deeding process. Furthermore, the new regulations specifically stated that the exchangor could receive the benefit of any interest earned while exchange funds were being held.

¹ Starker v. U.S., 602 F.2d 1341 (9th Cir. 1979)

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