Ever wonder when and how the 1031 exchange materialized? For those new to the Internal Revenue Code Section 1.1031 tax deferred exchange, the code states “no gain or loss shall be recognized on the exchange of property held for the productive use in a trade, business or for investment if such property exchanged solely for like-kind which is to be held for the productive use in a trade, business or for investment.” The 1031 exchange represents a tax deferral strategy where a property owner sells one or more relinquished properties for one or more like-kind replacement properties, deferring the payment of federal and state capital gains and recaptured depreciation taxes.
1031 Exchange Justification and History
The philosophy of the 1031 exchange is based upon the premise of a property owner who reinvests the sale proceeds and retired debt into a like-kind replacement property; their economic position has not changed. The taxpayer has not received the economic gain or cash to pay the taxes triggered by the sale. Consequently, to force the taxpayer to pay the tax would be unfair. The tax obligation does not go away, rather it is deferred until the replacement property is sold. Once the replacement property is sold and another 1031 exchange is not initiated, the original deferred gain plus any additional gain realized since the replacement property purchase is taxed.
The genesis of the 1031 surfaced hundreds of years ago when property owners bartered for property. Farmers would trade land for land or livestock for livestock. When a better horse or cow was traded, the farmer would request something in addition to equalize the value traded. That something extra may have been food, a weapon, an ax or money. These additional items of value or benefits were known as boot. Today, the idea of cash received or mortgage not replaced is viewed by the Internal Revenue Service as a benefit, taxable and commonly known as equity and mortgage boot.
The original 1031 exchange was legislated into law with the Revenue Act of 1921. The code remained without much change from 1928 to 1984, when time limits were imposed as a result of the Starker decision in 1979.
Prior to 1979, 1031 exchanges were accommodated in one day long closing where the relinquished property was closed, followed by the replacement property closing. The impact of the Starker decision was that 1031 exchanges did not have to close the same day; the closings could be delayed. What is now known as a forward exchange allows for the relinquished property to be closed followed on another day by the replacement property closing. In 1984, the 45 and 180 calendar day limits were imposed, requiring the potential replacement property to be identified by the 45th calendar day post-closing with the 1031 exchange completed no later the 180th calendar day post-closing.
In 1991, four safe harbors were created as a bright-line test to determine whether the taxpayer is in actual or constructive receipt of money or property while having initiated an exchange. One of these safe harbors is the use of a Qualified Intermediary to hold the exchange funds during the exchange period. The (g)(6) limitations of the 1031 code states that “in no event shall Exchangor receive, pledge, borrow, or otherwise obtain the benefits of the Exchange Account, including earnings, thereon, before the Exchange Period.” Once a taxpayer touches the exchange funds or receives a notes payable from the property buyer, it is considered boot and taxable. Use of safe harbors prevents the taxpayer from having access to the exchange funds.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.