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Where
did §1031 and “exchanges”
come from...?
In 1918, the U.S. enacted its
first income tax. At this time,
gain or loss was recognized on
the sale and disposition of all
property. To many legislators,
it did not seem fair to impose
taxes on dispositions involving
an exchange of property when the
taxpayer was essentially continuing
his investment in real estate.
Therefore, Section 202 of the
Internal Revenue Code (I.R.C.)
was enacted in 1921 which permitted
simultaneous Tax-Deferred Exchanges
of property.
In 1923, Congress removed stocks,
bonds, choses in action, notes
and deeds of trusts from exchanges.
Later in 1928, §202 was re-enacted
as §1031. However, exchanges
were still required to be simultaneous,
meaning that the parties basically
had to sit at a closing and trade
their deeds (and possibly cash
and/or other taxable property).
Because simply exchanging deeds
was such a cumbersome process
– and usually did not meet
the needs of the exchanging parties
– a lawsuit involving a
taxpayer, T.J. Starker, made things
easier for all of us. In 1979,
the landmark tax court case of
Starker v. Commissioner
(602 F.2d 1341 (9th Cir., 1979)
allowed the use of non-simultaneous
or “delayed” exchanges,
which is what 99% of people do
today. This allows someone to
sell their property, place the
proceeds in trust with a Qualified
Intermediary (hopefully, in a
separate, interest-bearing account!),
and purchase a new property using
the proceeds held by the QI.
However, by allowing delayed exchanges,
Starker created
an administrative nightmare for
the IRS and an enormous potential
for abuse of the tax code. There
were just no ground rules for
performing delayed exchanges.
Therefore, the IRS passed a number
of amendments to §1031 in
1984 to retain more control over
exchanges - primarily the 45-day
identification period and
180-day
closing period. Later, in
1991, the IRS put further controls
on §1031, including rules
regarding identification of properties
(3 properties and the 200%
rule), safe harbors to avoid
constructive receipt of proceeds,
parties disqualified from acting
as a QI, and improvement exchange
guidelines. Finally, in 2000,
the IRS passed safe-harbors for
reverse exchanges.
§1031 is a constantly evolving
section of the tax code –
with plenty of gray areas. Real
estate investors need a reliable
source for keeping up to date
on the latest trends and developments.
Please feel free to call The 1031
Exchange Experts with any questions
you may have.
--The
Experts
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