Section 1031 of the Internal Revenue Code has a very long and somewhat complicated history dating back to 1921. The first income tax code was adopted by the United States Congress in 1918 as part of The Revenue Act of 1918, and did not provide for any type of tax-deferred like-kind exchange. The first tax-deferred like-kind exchange was authorized as part of The Revenue Act of 1921, when the United States Congress created Section 202(c) of the Internal Revenue Code, allowing Investors to exchange securities and non-like-kind property unless the property acquired had a 'readily realizable market value.?

These non-like-kind property provisions were quickly eliminated with the adoption of The Revenue Act of 1924. The Section number applicable to tax-deferred like-kind exchanges was changed to Section 112(b)(1) with the passage of The Revenue Act of 1928. In 1935, the Board of Tax Appeals approved the first modern tax-deferred like-kind exchange using a Qualified Intermediary and the 'cash in lieu of' clause was upheld so that it would not invalidate the tax-deferred like-kind exchange.

The 1954 Amendment to the Federal Tax Code changed the Section 112(b)(1) number to Section 1031 of the Internal Revenue Code and adopted the present day definition and description of a tax-deferred like-kind exchange, laying the groundwork for the current day structure of the tax-deferred like-kind exchange transaction.

The tax court cases and corresponding decisions, including an appellate decision from the 9th Circuit Court of Appeals resulting from the now famous Starker family tax-deferred like-kind exchange transactions, changed the tax-deferred like-kind exchange industry forever. The Starker family litigation stemmed from two delayed tax-deferred like-kind exchange transactions where T.J. Starker and his son Bruce Starker sold timberland to Crown Zellerback, Inc. in exchange for a contractual promise to acquire and transfer title to properties identified by T.J. Starker and Bruce Starker within five (5) years. The Internal Revenue Service disallowed this arrangement, contending, among other things, that a delayed exchange did not qualify for non-recognition treatment (i.e. deferral of income tax liabilities).

These tax court decisions were significant in numerous ways and set the precedent for our present day non-simultaneous, delayed tax-deferred like-kind exchange transactions.

The Starker family cases demonstrated to the investment community that non-simultaneous, delayed tax-deferred like-kind exchanges will qualify for non-recognition treatment, which provided Investors with significantly more flexibility in the structuring of tax-deferred like-kind exchange transactions.

In addition, the concept of a 'growth factor' was introduced. The Starker family's tax-deferred like-kind exchange transactions were structured so that Crown Zellerback would compensate the Starker family with a 'growth factor.? This growth factor was essentially designed to compensate the Starker family with interest income for the lost use of their timberland and was based on the assumption that timber grew by a certain annual percentage, or annual growth rate, each year, and since the Starker family had conveyed or transferred their property to Crown Zellerback with out any immediate compensation they should be compensated for the lost growth rate in timber until their like-kind replacement property had been acquired by Crown Zellerback and conveyed or transferred to the Starker family. The courts ruled that the 'growth factor' or 'disguised interest' was interest income and must be treated and reported as ordinary income (interest income).

The Starker family tax-deferred like-kind exchange tax court decisions established the need for regulations regarding delayed tax-deferred like-kind exchanges and prompted the United States Congress to eventually adopt the 45 calendar day Identification Deadline and the 180 calendar day Exchange Period as part of The Deficit Reduction Act of 1984, which also 'codified' or adopted the delayed tax-deferred like-kind exchange provisions that we have today. The Deficit Reduction Act of 1984 also amended Section 1031(a)(2) of the Internal Revenue Code to specifically disallow exchanges of partnership interests (See Section on Partnership Issues).

The Tax Reform Act of 1986 is responsible for the tremendous explosion in the number of tax-deferred like-kind exchange transactions administered today. The Tax Reform Act of 1986 eliminated preferential capital gain treatment so that all capital gains were taxed as ordinary income, enacted 'passive loss' and 'at risk' rules, and eliminated accelerated depreciation methods in favor of straight line depreciation consisting of 39 years for commercial property and 27.5 years for residential property. These changes significantly restricted the tax benefits of owning real estate and catapulted the tax-deferred like-kind exchange into the lime light as being one of the few income tax benefits left for real property Investors.

The Revenue Reconciliation Act of 1989 resulted in a few changes to the tax-deferred like-kind exchange arena, including the disqualification of tax-deferred like-kind exchange transactions between domestic (United States) and non-domestic (foreign) property and placed restrictions on related party tax-deferred like-kind exchange transactions in the form of a two year holding period requirement.

The long awaited proposed tax-deferred like-kind exchange rules and regulations were issued by the Department of the Treasury effective July 2, 1990. The proposed rules and regulations specifically clarified the 45 calendar day identification period and the 180 calendar day exchange period rules, provided guidance on how to deal with actual and constructive receipt issues in the form of safe harbor provisions, reaffirmed that partnership interests do not qualify as like-kind property in a tax-deferred like-kind exchange transaction, and further clarified the related party rules.

The proposed tax-deferred like-kind exchange rules and regulations were issued as final rules and regulations effective June 10, 1991 with only a few minor adjustments, including the further clarification and definition of what constitutes a 'simultaneous exchange' and an 'improvement exchange,? and which parties were disqualified from serving as a Qualified Intermediary (Accommodator).

The Tax Relief Act of 1997 attempted to significantly change Section 1031 of the Internal Revenue Code, but failed. There have been a number of attempts to alter portions of the 1031 exchange code and regulations ever since, but none have been successful to date.

The issuance of Revenue Procedure 2000-37 gave Investors and Qualified Intermediaries guidelines on how to structure reverse tax-deferred like-kind exchange transactions where the Investor's like-kind replacement property can be acquired before he disposes of his relinquished property. This reduced the risk associated with the 45 calendar day identification period.

The introduction of Revenue Procedure 2002-22 has arguably had the most significant impact on the tax-deferred like-kind exchange industry since the Tax Reform Act of 1986. It provided Investors with an additional like-kind replacement property option that had not existed before ? Co-Ownership of Real Estate (CORE) ? and is partially responsible for the explosive growth in the number of tax-deferred like-kind exchange transactions between 2002 and 2005.

Recent legislation indicates that the legislative pendulum may be swinging in the other direction: the most recent modification within the realm of Section 1031 served to expand its application, rather than restrict it.

Revenue Procedure 2005-14 was issued and made effective on January 27, 2005 and made it possible for the first time for homeowners to use the tax-deferral mechanism of Section 1031 on their primary residence, if done in conjunction with the specific strategy delineated under the Revenue Procedure. So long as the property in question satisfies the requirements for both Code Sections 1031 and 121, then the Section 121 Exclusion operates to exclude from taxable income either 250,000 or 500,000 of the gain from the sale, exchange or disposition of the property and any additional gain may be deferred by reinvesting in like-kind replacement property through a tax-deferred like-kind exchange.

Section 1031 of the Internal Revenue Code

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