What is a 1031 Exchange?

The 1031 exchange is a widely utilized tax strategy for individuals engaged in selling and purchasing real estate designated for productive use in a business or investment. It is also known as a like-kind exchange or LKE. The pivotal legal case of T.J. Starker v. U.S., 602 F. 2d 1341 (9th Cir. 1979), significantly shaped the rules governing 1031 tax exchanges. In this case, the Ninth Circuit Court established the permissibility of non-simultaneous 1031 exchanges, setting the groundwork for the present 180-day non-simultaneous, delayed tax-deferred like-kind exchange transactions, often referred to as Starker Exchanges or Starker Trusts.

The concept of a tax-deferred exchange was initially authorized in 1921 by Congress, recognizing the importance of promoting reinvestment in business assets. Nowadays, taxpayers employ 1031 exchanges to enhance their cash flow by postponing taxes on gains generated from the sale of real estate, provided they reinvest those gains into replacement properties. In practical terms, a taxpayer sells a property used for business or investment with the intention of exchanging it for another property also intended for business or investment purposes. During this exchange, the taxpayer does not personally handle or control the proceeds from the sale of their relinquished property. These funds are directly utilized to acquire the replacement property. Because the taxpayer never actually receives the proceeds from the sale, they can delay paying taxes that would otherwise be due if they had simply sold the property and retained the money.