The History of Tax-deferred Exchanging

You may have just recently heard about the advantages of a tax-deferred exchange, but tax-deferred exchanges have actually been in the Internal Revenue Code since 1921!

Starting then, it was recognized that if a taxpayer sold business or investment property and re-invested all the cash proceeds in replacement property, there was no money available to pay the capital gains taxes. The taxpayer was allowed to defer those taxes. Originally, in order to execute a tax-deferred exchange, taxpayers had to find another person to swap properties with them.

In the 1930's, it became acceptable for the exchanging taxpayer to use an accommodator to complete the exchange. For example, Jeff wants to exchange his duplex for a different rental property. Denise wants Jeff's duplex, but Denise does not own any property that Jeff wants. Denise acquires a new property suitable to Denise and uses that property to swap with Jeff. Denise is acting as Jeff's accommodator.

Then, in the 1970's, taxpayers were allowed to transfer the old property to a buyer and receive the replacement property sometime in the future, rather than in a simultaneous swap. That was the birth of what is now commonly known as a delayed exchange.

The really big changes came in 1991, when the Treasury Department developed extensive Regulations to establish the 45-day Identification Period, the 180-Day Exchange Period, and the use of Safe Harbors (the Qualified Intermediary and the Qualified Escrow Holder), to facilitate the exchange process.

For example, Denise wants to buy Jeff's duplex. Under the 1991 Regulations, Jeff transfers the duplex to Denise through a Qualified Intermediary and the sale proceeds are deposited with a Qualified Escrow Holder. Within 45 days of that closing, Jeff must identify replacement property and he must acquire (take title) to the replacement property within 180 days of his transfer to Denise. If the exchange is properly documented and executed, Jeff gets the same deferred tax treatment as if he had swapped properties with Denise.

So you see, tax-deferred exchanging is not really a new concept. However, the current method of executing an exchange is fairly recent and certainly user-friendly.