1031 Exchanges

Due to the inflationary spiral, along with the deduction of depreciation upon the value of real estate, many investors are faced with enormous capital gains upon the sale of their investment property. Whereupon, the question arises as to the method one can utilize the disposition of investment property without realizing capital gains. Section 1031 of the Internal Revenue Service is the answer. Section 1031 provides that “no gain or loss shall be recognized if property held for productive use in trade or business, or for investment, is exchanged solely for property of a like-kind to be held either for productive use in trade, business, or for investment.” The wording of Section 1031 tells us that “like-kind” means of a similar nature as long as both the property given up and the property received are used in the Sellers trade or business. It is immaterial what the buyer does with your property he or she acquires. The biggest problem confronting the taxpayer desiring to exchange property was that the potential buyer of the taxpayer’s property owns no property that the taxpayer wishes to receive in exchange. Therefore, a transaction so-called “three-corner” exchange evolved. The Tax Court has agreed that this is an exchange within the meaning of Section 1031. e.g., Alderson vs. Commissioner, 317 F. 2d 790 (9th Cir 1963) State of California rev. 38 T.C. 215 (1962). The courts have also agreed, that “It is immaterial that the exchange was motivated by a wish to reduce taxes”. Mercantile Trust Company of Baltimore et al. Trustees vs. Commissioner, Supra at 87. One of the most publicized court cases to support Section 1031 was the “Starker” Case, U.S. T.C. No. 77-2826. This paramount decision allows a contractual purchase of property for a future exchange. In other words, there does not have to be a simultaneous closing of escrow as long as the proceeds do not come under the control of the seller. To prevent such control by the seller, Pacific Financial Exchange Corporation, A California Corporation, will act as a “substituted seller” so that the IRS cannot argue that the seller had actual control. Therefore, Pacific Financial Exchange Corporation will hold the proceeds of the sale until a suitable property of “like-kind” can be found. The legal basis for this transaction can be found in; F.B. Biggs vs. Commissioner 69 T.C. No. 78 (1978), T. J. Starker vs. Commissioner 77-2 U.S. T.C. No. 9512, Leslie Q. Coupe 52 T.C. No. 394 (1960). These are only a few cases involving application of I.R.C. 1031. We advise you to discuss these and other cases with your Tax Advisor and or your Attorney prior to entering into this or other similar transactions.