The History of 1031 Exchanges

History of 1031 Exchange

The United States Congress enacted the first exchange statute through the Revenue Act of 1921. The act, which allowed both like-kind and non-like-kind exchanges for a legal, regulated tax-deferred exchange had three purposes:

  • To avoid unfair taxation of investments in property that are ongoing
  • To encourage active reinvestment
  • For administrative convenience

The third became irrelevant as policy changes were enacted, but the first two are even more germane to today’s investors than they were back in 1921.

Congress believed it was important to not punish investors, through capital gains taxes, during the course of continuous investment. They wrote:

In other words, profit or loss is recognized in the case of exchanges of notes or securities, which are essentially like money; or in the case of stock in trade; or in case the taxpayer exchanges the property comprising his original investment for a different kind of property; but if a taxpayer’s money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit. The calculation of the profit or loss is deferred until it is realized in cash, marketable securities, or other property not of the same kind having a fair market value.”

The goal of allowing a tax-exemption on continuation of a taxpayers investment through different, but like-kind, property, was at the root of Congress’s intention in enacting the statute.

The original statute was modified through the Revenue Acts of 1924 and 1928. In 1935, the Board of Tax appeals added safe-harbor through Qualified Intermediaries, to make sure the taxpayer didn’t receive proceeds or other property during an exchange.

A 1954 Amendment to the Federal Tax Code changed the exchanges to Section 1031. The current language defining and describing tax-deferred, like-king exchanges was adopted and these exchange transactions took their modern form.

The industry was dramatically changed by a case in the late 1970s. That’s when T.J. Starker transferred his timber property to Crown Zellerbach Cooperation, with the promise that Crown would transfer like-kind property over a five-year period.

The IRS stepped in and denied the transaction. They argued that the exchange required a simultaneous swap. The case went to court, and in a landmark decision, the Ninth Circuit Court ruled against the IRS. Starker and Crown’s were allowed to make their exchange.

A few years later, Congress set the 45-calendar day identification deadline and 180-calendar-day exchange period and outlawed exchanges of partnership interests as part of the Deficit Reduction Act of 1984. Preferential capital gains treatment were eliminated in the Tax Reform Act of 1986.

In 1990, the Department of Treasure issued tax-deferred like-kind exchange rules and regulations, providing guidance and clarifying rules. More guidelines were given to investors through Revenue Procedure 2000-37, and in 2002, Revenue Procedure 2002-22 had the most significant impact on the industry since 1986 and was responsible for a big growth in 1031 exchange transactions.

Recently, in 2012, the JOBS Act allowed private equity crowdfunding for real estate investments, giving investors access to replacement properties digitally. And in 2018, the Tax Cuts and Jobs Act, preserving exchanges of real estate, but disallowing personal property assets from 1031 exchanges.





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