Although the 1031 industry is relatively new, going back just several decades, Section 1031 is nearly 100 years old. The 1031 industry has come about only because the Treasury Regulations have codified delayed exchanges and established the role of facilitators.
Before these regulations, the contours of 1031 exchanges were still quite fuzzy. Repeatedly, courts stressed that the actual result of a given transaction held the most weight. The importance placed on the actual result was meant to further emphasize the importance of substance over form. Even if a taxpayer engaged an intermediary to complete an exchange, what really mattered was whether the taxpayer did in fact receive like-kind property at the close of the transaction.
The Third Time Was The Charm
One case which impacted the development of Sec. 1031 more than any other was the final Starker case of 1979. This case is actually the third Starker case to be heard by the courts. This final case reinforced the primacy of the actual result and gave express approval to a “delayed exchange” which occurs over a period of time.
In this post, we will go over the facts of this very important case, cover its procedural history, ruling, and then briefly discuss its wider significance. Because of the new Treasury Regulations, we won’t see a case with the same set of facts as this one again, but we will continue to see the impact of this case for as long as the current regulations stay on the books.
Facts of Starker
The taxpayer developed a contract with a corporation. The contract held that the taxpayer would give several parcels of timberland to the corporation. In exchange, the taxpayer would receive a “credit account” with the corporation. To redeem these credits, the taxpayer would specify a given property which he wished to receive. The taxpayer would receive additional credits on top of those awarded specifically for the parcels transferred to the corporation. These additional credits were deemed to represent the interest or “growth factor” accrued during the time that the credit account was open. Ultimately, the taxpayer received 15 parcels of land over a period of years. The taxpayer contended that the transaction with the corporation constituted an exchange under Sec. 1031. Essentially, this is a “delayed exchange,” but the events in question took place well before this concept was really fleshed out.
As mentioned, this was the last of three different “Starker” cases. The first Starker case involves a Bruce Starker, the son of TJ Starker. TJ Starker was the subject of the two subsequent Starker cases. The two subsequent cases were decided in 1977 and later, in 1979.
The final Starker case presented three distinct legal issues. The relevant issue, for us, is the third issue. The taxpayer argued that the initial court erred when it denied Sec. 1031 nonrecognition treatment for the transaction between himself and the corporation. The question before the appellate court was: is a contract for a right to acquire property in the future, an “exchange” within the meaning of Sec. 1031? The appellate court held that what took place was, in fact, an exchange. In making its decision, the court stated that a Sec. 1031 exchange doesn’t need to involve a simultaneous exchange of like-kind properties. There doesn’t need to be an immediate transfer of interest or title. In the Starker case, the transaction occurred over a number of years. Nonetheless, the court held that this was acceptable under Sec. 1031.
The Significance of the Starker Case
This final Starker case was of immense importance to the development of Sec. 1031. In point of fact, one could argue that it’s second to none in terms of overall importance. After the 1979 Starker case, the concept of the “delayed exchange” took basic form, and ultimately this led to the creation of the Treasury Regulations.
Delayed Exchanges and Growth
The significance of the Starker cases was immediately recognizable by the legal profession. In addition to paving the way to the modern conception of the delayed exchange, the Starker case also contributed toward the acceptance of a “growth factor” during an exchange. Taxpayers in modern Sec. 1031 exchanges routinely receive interest on their investment while their exchange proceeds are held in a bank account. Interest is actually the dominant source of income for most 1031 facilitators. Facilitators bargain for a percentage of the interest generated for a client’s exchange in addition to a flat exchange fee.
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