What is a 1031 Exchange?
An exchange is a real estate transaction in which a taxpayer sells real estate held for investment or for use in a trade or business and uses the funds to acquire replacement property. A 1031 exchange is governed by Code Section 1031 as well as various IRS Regulations and Rulings.
Section 1031 provides that “No gain or loss shall be recognized if property held for use in a trade or business or for investment is exchanged solely for property of like kind." The first provision of a federal tax code permitting non-recognition of gain in an exchange was Code Sec. 202(c) of the Revenue Act of 1921. Section 1031 has existed in the Internal Revenue Code since the first Code in 1939. It remains identical with only two additions in more than 75 years.
Section 1031 on its face appears to permit only a direct exchange of properties between two taxpayers. Following the decision in 1979 in Starker v. U.S. taxpayers were permitted to structure deferred exchanges in which the taxpayer sold the Relinquished Property to a buyer and acquired Replacement Property from a seller using the Realized Proceeds. Deferred exchanges are often called “Starker” exchanges. The Internal Revenue Service challenged deferred exchange but the Tax Court was liberal in allowing them and in 1991 the Internal Revenue Service adopted Regulations permitting them and governing their structure.