The modern day delayed 1031 exchange, often referred to as a Starker exchange, has its roots back at the turn of the 20th century when T.J. Starker began investing in second-growth forest in Oregon. By the 1960s, T.J.’s son Bruce was part of the family business. T.J. and Bruce were able to purchased second-growth forest at a very low cost basis. As the forest land began to regrow, the value of the land increased substantially. Selling the land outright exposed the Starker’s to substantial capital gains taxes. Section 1031 of the Internal Revenue Code, which allowed a capital gains deferral for like-kind exchanges, had been in place since 1921. The problem was that up to that point, Section 1031 had been interpreted to apply only to a simultaneous exchange of like-kind property. Not surprisingly, this was often difficult to accomplish.
Starker 1031 Exchange
Crown-Zellerbach & Longview Fibre contacted the Starker family with the intent of purchasing Starker property. A deal was eventually made to sell property for $1.6 million. Crown-Zellerbach did not have property available at the time that would qualify for a like-kind exchange so an innovative solution was created. The Starker’s received “exchange credit” from Crown-Zellerbach instead of cash. Crown-Zellerbach then purchased property over the next couple of the years that would qualify as “like-kind” and deeded it to the Starker’s in exchange for the “exchange credit”. When the Starker’s completed their income tax returns, they claimed a 1031 exchange deferral for the capital gains taxes. The IRS denied the Starker’s claim. The Starker’s appealed the decision and the resulting litigation ultimately defined what is known as the modern day deferred 1031 exchange.
The most important decision that came out of the Starker case was the court’s conclusion that a seller could delay the purchase of qualifying “like-kind” property for 180 days after the initial sale. In order to qualify for the deferral, “like-kind” property must be identified within 45 days after the initial sale and the exchange transaction must be completed within 180 days. In addition, a Qualified Intermediary must be used to facilitate the transaction. A Qualified Intermediary is required to hold the proceeds of the sale in a trust or escrow account until an exchange property is identified. The Qualified Intermediary also transfers the initial property to the original buyer and the exchange property to the original seller.
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