Tax deferred exchanges have been around since the 1920's. The problem was that to do a tax-deferred exchange, you had to do a simultaneous exchange. Generally, it was very unlikely to find two parties who wanted each other's property. Sometimes three or more people would get involved: swapping properties with each other at the same time. The logistics of these exchanges made them complicated and very expensive.
|
1921 |
Sec. 1031 becomes law |
|
1979 |
Starker Case - The 9th Circuit Court approves a non-simultaneous exchange |
|
1984 |
Sec. 1031 Revised- To allow for delayed exchanges. The 45-day & 180-day rules are introduced. |
|
1991 |
New IRS Regulations- “Safe Harbor” provisions for Qualified Intermediaries (QI’s) and 45-day identification requirements. |
|
2000 |
Revenue Procedure 2000-37- IRS issues guidelines for reverse exchange safe harbor. |
|
2002 |
Revenue Ruling 2002-83- IRS issues guidelines for related party exchanges. Replacement property acquired from a related party does not qualify as like-kind if the related party receives cash or other non like-kind property |
Today, tax deferred exchanges are very practical and easy to use. The change came about because of the famous "Starker" case (a loss for the IRS) and the subsequent issuance of new guidelines in 1991. In addition, a delayed exchange allows you to sell your property to any party you choose and buy your replacement property from any party you choose. The guidelines provide a number of "safe harbors" which allow for a successful tax-deferred exchange. With an experienced professional guiding your transactions, you can be assured that your tax-free exchanges are easy, worry-free and most important, safe. The chart at the right offers a summary of the main changes to section 1031 throughout history.
The Starker Case
T.J. Starker, his son Bruce, and daughter-in-law Elizabeth owned 1,843 acres of timberland in Columbia County, Oregon (northwest corner of Oregon, St. Helens is the county seat). In 1967, two companies, Crown Zellerbach (Crown) and Longview Fibre (Longview), offered to purchase the acreage. The timber companies were anxious to harvest the timber; however, the Starkers had not located suitable replacement property yet. The Starkers were willing to sell but wanted to defer their capital gains on the land via an exchange. To solve both parties’ problems, the Starkers entered into a contractual agreement to convey the unencumbered lands to Crown and Longview in exchange for a promise to deliver suitable replacement properties to the Starkers in the future.
On April 1, 1967, Bruce and Elizabeth entered into a “Real Estate Exchange Agreement” with Longview and conveyed property to Longview. Longview set up “book credits” of $105,811 in favor of Bruce and Elizabeth. They referred to this account as an “Exchange Value” account for the timberland. Each year until the credits were spent, the Exchange Value account would be increased by a 6% “growth factor” which was supposed to reflect the growing timber. Under the contract, the Starkers did not have control of ANY cash.
At the same time, T.J., Bruce, and Elizabeth entered into a “Land Exchange Agreement” with Crown and conveyed their timberland. T.J. Starker’s exchange credits with Crown were $1,502,000 and Bruce and Elizabeth’s exchange credits were $73,000. Again, the 6% growth factor applied and there was NO control of the cash. However, at the end of 5-years, the Starkers would receive any remaining balance in cash.
As suitable replacement property was found by the Starkers, Crown and Longview purchased the property, deeded it to the Starkers and reduced the Starkers’ “Exchange Value” account. Longview conveyed eight parcels to Bruce and Elizabeth between 1968 and 1972, reducing their credit balance to zero. Crown conveyed three parcels to Bruce and Elizabeth reducing their balance to zero. T.J., having more credits to spend, did not receive all of his property for almost two years. He received twelve parcels, two of which were actually an assignment of a purchase contract. No cash was paid to the Starkers. The Starkers filed their tax returns for 1967 treating these transactions as tax-exempt transfers. The Internal Revenue Service has laid the groundwork for the challenge of “non-simultaneous” exchanges.
The IRS disallowed all of the exchanges because the IRS believed that exchanges could only qualify if all properties involved were transferred simultaneously. The IRS said there could be no amount of time between the transfer of the relinquished property and replacement property in an exchange. The Starkers paid their taxes and filed suits in the U.S. District Court in Portland, Oregon. Three court cases ensued, tried by District Judge Gus Solomon:
Starker 1
The first involved Bruce and Elizabeth Starker (Starker I- 1975). The IRS first filed a deficiency notice against Bruce and Elizabeth Starker. The Starkers paid the tax and sued for a refund. In a very short opinion, the court decided in favor of Bruce and Elizabeth Starker while making no mention of the fact that the exchanges were not simultaneous.
Starker II
In 1977, the government filed suit against T.J. Starker (T.J. Starker v. U.S., 431 F. Supp. 864 D. C. Ore. 1977). This time the court, the same one that ruled in Starker I, found that there was no exchange and that a taxable sale had taken place. This case reversed the first decision. Judge Solomon wrote he was mistaken in Starker I and stated, “My opinion in Starker I has been given wide publicity. I believe that it is desirable that my opinion in this case be published to prevent the mischief that I believe Starker I has caused.” He further wrote that T.J. Starker had exchanged real property for a promise that was not like-kind under the statute. He ruled that the growth factor was taxable as interest.
Starker III
The third and final case was T.J. Starker’s appeal (T.J. Starker v. U.S., 602 F. 2d 1341 9th Cir. 1979). The Ninth Circuit Court ruled that the government was collaterally stopped by Starker I from re-litigating nine of the transfers overturned in Starker II. Most importantly for real estate investors, the Court could not find any requirement for simultaneity in the 1031 tax code. The court found there was no limit on the time between the transfer of the relinquished property and the acquisition of the replacement property. The court ruled in favor of Starker. The delayed exchange was born!
Starker Biographies
Thurman James (T.J.) Starker (1890-1983):
T.J. was one of the first four forestry graduates from Oregon Agricultural College (now Oregon State University) in 1920. He completed his master’s degree in forestry at the University of Michigan and joined the faculty of the OAC School of Forestry in 1922. He was a professor there until 1942, when he left to manage his forestlands.
T.J. had the foresight to purchase second growth forest parcels beginning in 1936. Why were they second growth? The lands T.J. purchased had either been burned by Native Americans (a practice to create better habitat for the animals they hunted and for the roots and berries they gathered) or had been cleared by homesteaders who went bankrupt during the Great Depression. At the time, few people placed much value on second-growth parcels, since no one envisioned that then-plentiful old-growth forests would someday be in short supply. T.J. based his land purchases on several criteria. First, the land had to have no snags on the ridges, gentle terrain, and good drainage. Most important of all, however, was that the land be a good buy!
Throughout his career, T.J. stressed the importance of regeneration of timberland. He was highly regarded for his contributions as an educator, forester, and active citizen.
T.J. formed Starker Forests in 1971 as the entity to manage the family forests. The partnership became Starker Forests, Inc. in 1981. T.J. remained with the company until his death in 1983.
Despite all his work in the forestry arena, T.J. Starker is best known for his contribution to U.S. federal tax law. He was involved in a 1977 court cased over a delayed exchange he arranged with a buyer of some of his forestlands. Starker eventually won the case on appeal in 1979 which eventually changed all the rules regarding exchanges, resulting in an explosion of real estate exchange transactions beginning in 1984, with changes to the exchange rules in the Internal Revenue Code, and new regulations in 1991.
Bruce Starker (1919-1975)
Bruce was the son of T.J. and Margaret Starker. Bruce graduated from Oregon State College with a forestry degree in 1940. He later earned a master’s degree in forest management from Yale. He served in World War II, and then returned to join his father in the purchase and management of their forest holdings. Bruce’s main interest was forest management, by which he hoped to maintain perpetual forests for both public and private use through reforestation and sound forest conservation practices.
Bruce was a partner in Starker Forests up to his death from an airplane crash in 1975.
Starker Forests, Inc.
Starker Forest was formed in 1971. The partners were T.J. Starker, son Bruce Starker, Bruce’s wife Betty (Elizabeth) and Bruce and Betty’s two sons, Bond and Barte (also OSU forestry graduates). After Bruce’s death in 1975, Betty, Bond, Barte and Gary Blanchard took over management of the company. Starker Forests, Inc. was formed in 1981.
Starker Forests, Inc. today holds approximately 60,000 acres of forestlands in Benton, Lincoln, Lane and Polk Counties. Bond, Barte and a staff of dedicated, longtime Starker foresters and professionals headed by Chief Forester Gary Blanchard currently manage the land. In addition to practicing intensive forest management, the people at Starker Forests also promote and encourage recreational use of their lands with a free Starker Forests permit.