The History and Purpose of the 1031 Exchange Provision
Section 1031 is a provision in the Internal Revenue Code (IRC) that allows taxpayers to defer recognizing gain on qualifying like-kind exchanges when they work with a 1031 qualified intermediary. This tax deferral can carry over from one like-kind exchange to the next—effectively deferring taxpayers’ liability indefinitely.
So, why does Section 1031 exist? With the national deficit and tax gap, why doesn’t the Internal Revenue Service (IRS) seek to collect income tax on all profitable exchanges—regardless of whether the properties involved are of like kind? To understand why Section 1031 exists, we have to take a look back at its history and purpose.
The History of the Section 1031 Like-Kind Exchange Provision
The Section 1031 like-kind exchange provision is more than 100 years old. Enacted in 1921 as part of the federal Revenue Act, the original purpose of Section 1031 was to encourage investment in real estate. By allowing real estate investors to defer recognizing taxable gain, the Revenue Act enhanced their investing power—encouraging more investment and helping to boost the nation’s already bustling economy.
This latter point is important, as it provides historical context for Section 1031. When President Harding signed the Revenue Act on November 23, 1921, the national deficit was in decline (down to 23.9 billion from 29.4 billion in 1919); and, with a strong economy, the U.S. Treasury Department was generating sufficient tax income through other means. In theory, allowing deferral of gain from like-kind exchanges would generate more commerce and more spending, and this would ultimately benefit both the American public and the U.S. government financially.
Over the next several decades, while the United States transformed, Section 1031 largely remained the same. Real estate investors continued to use like-kind exchanges to grow their portfolios, and individuals and families that could afford homes after the nation rebounded from the Great Depression used Section 1031 to buy bigger and nicer houses as they climbed the economic ladder. But, in the 1970s, things started to get more complicated.
The reform we’ve seen over the past 50 years under Section 1031 (including the requirement for the use of a 1031 qualified intermediary when one like-kind asset is not exchanged directly for another) largely stems from a single court case in 1979. In Starker v. United States, the U.S. Court of Appeals for the Ninth Circuit approved the first-ever delayed like-kind exchange under Section 1031. Not only did the Ninth Circuit allow members of the Starker family to conduct a delayed like-kind exchange, but it also gave them a five-year time window to purchase the replacement property.
This led to statutory reform in the 1980s, and in 1991, the IRS adopted the Section 1031 Regulations. These regulations establish the procedures for conducting delayed like-kind exchanges without triggering federal income tax liability (including the use of a 1031 qualified intermediary and placing sale proceeds in trust pending the purchase of replacement property). In the years since, we’ve seen several changes to Section 1031 and the IRS’s regulations, including the most recent changes implemented by the Tax Cuts and Jobs Act of 2017. While much of the previous reform was focused on facilitating the use of the 1031 like-kind exchange provision, with the Tax Cuts and Jobs Act, Congress restricted the types of property that can be bought and sold in transactions that are eligible for tax deferral.
The Purpose of the Section 1031 Like-Kind Exchange Provision
So, what is the purpose of Section 1031 today? In its current form, the Section 1031 like-kind exchange provisions are once again primarily intended to encourage real estate investment. The current 1031 exchange requirements make this clear, although they do not completely rule out like-kind exchanges involving other types of property.
For individuals and businesses that qualify, conducting a like-kind exchange with a 1031 qualified intermediary can facilitate significant (and potentially indefinite) tax savings. Section 1031 is a powerful tax planning tool for all taxpayers who own eligible property—as long as they take the necessary steps to comply with the current like-kind exchange requirements.
Learn About Our 1031 Qualified Intermediary Services
At 1031 National Services, we provide 1031 qualified intermediary services to individuals and businesses nationwide—and we have been doing so since 1994. If you have questions about conducting a delayed like-kind exchange under Section 1031, we invite you to contact us for a free consultation. To schedule an appointment at your convenience, please call 888-872-1031 or tell us how we can help online today.