The 1031 exchange is a masterful piece of tax strategy that can save savvy investors a lot of money as they buy and sell commercial property. The 1031 exchange that we know today is still being affected by tax code changes, and it’s been evolving for more than 100 years.
The Origin Of The 1031 Exchange
The first form of the 1031 exchange was born out of the passage of the Revenue Act of 1921. The goal of the tax code was to encourage investment and growth in America’s real estate market. The premise of the original 1031 exchange tax code remains largely similar to this day, as it allows for the exchange of one property for another without incurring capital gains or related taxes on the sale of the original property, so long as that money is put towards the purchase of a similar-styled property. This move allowed investors to keep their money in real estate and continue to purchase and develop new properties, which was seen as largely beneficial for citizens, communities and the country as a whole.
Of course, tweaks and updates to the tax code were necessary as the decades rolled on. While minor updates were made along the way, the biggest change came in 1979. That occurred when the 9th US Circuit Court of Appeals provided a ruling in TJ Starker v. United States. This decision effectively placed a five-year timeline on when the exchange needed to be completed to be legal.
Not surprisingly, that timeline was reigned in a bit just a few years later. In 1984, Congress codified 45- and 180-day identification and purchase period windows, and prohibited exchanges wherein a partnership interest exists. Then in 1991, more protections were added. Purchasing funds were allowed to be put in a trust or escrow, and the use of a Qualified Intermediary, which brought a neutral third party into the process to facilitate a safer and smoother sail, was introduced.
Some additional changes we’ve seen in recent years include:
2005 - Updates were passed on how rental property converted to a primary residence, and vice versa, were handled in a 1031 exchange.
2008 - Added regulations when investing/exchanging vacation/second homes.
2017 - Personal property removed from 1031 exchange treatment.
However, the original nature of the law first passed in 1031 remains the same, which is that you can avoid paying capital gains taxes when selling one commercial property and using those funds to purchase a similar like-kind property.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
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