Starker exchange

Starker v. United States

The US Appeals Court decision in Starker v. United States is likely the most well-known of any court case related to 1031 Exchanges, to the point where an occasional alternative name for what we refer to as a 1031 Exchange is a Starker Exchange. This case was the catalyst for the creation of law defining how an exchange of property can occur over time, which prompted the IRS to create the rules that thousands of investors take advantage of every year to defer capital gains taxes.

The facts behind the case are a little bit complicated, but they are important for understanding what happened:

T.J. Starker and his son and daughter-in-law (Bruce and Elizabeth Starker) were the owners of a large plot of forestland. In April 1967 they all agreed to give the land to a logging company in exchange for multiple plots of real estate totaling the same value as the forestland they gave to the company, with the plots deeded to them over the course of five years. Part of the deal was that if not enough land was deeded to them, the remaining value would be given to them in cash. The company was able to provide them with real estate equivalent to the forestland in about two years.

Both T.J. Starker and his son reported the transaction as a non-taxable exchange of property under Section 1031 of the tax code. The IRS contested this in both cases and required both taxpayers to pay the capital gains and penalties. Both taxpayers separately paid the penalties, then sued the IRS in federal tax court for a refund.

The judge in Bruce and Elizabeth’s case found in their favor, and ordered that they receive a refund; however, when T.J. Starker’s case reached the same judge’s bench, he found that T.J. Starker had to pay taxes, even commenting that he had made the wrong decision in the previous case. T.J. Starker appealed this decision to the Court of Appeals for the Ninth Circuit.

Part of the reason the tax court judge ruled against T.J. Starker was the complicated nature of the properties he accepted in exchange for his portion of the land. He had asked that some of the properties not be deeded to him but instead be deeded to his daughter. He moved into one of them after his daughter took ownership. one of the properties he accepted was not real estate but a contractual right to purchase real estate later. Another factor that affected the ruling was that the company had promised that the value of the credit to the Starkers would grow each year, to account for the growth of the trees on the land that they gave to the company. The tax court asserted that this increase in value amounted to income, not capital gains, and should be taxed as such.

The US Ninth Circuit ruled partially in favor of T.J. Starker, saying that the properties he received did constitute an exchange, and that he was owed a refund for the capital gains. They confirmed that the increase in value was income, not gains, so he still owed income tax on that portion.

The finding in this case set a precedent that taxpayers could perform an exchange of property over a number of years, rather than an exchange transaction having to occur simultaneously. This precedent prompted the Department of the Treasury to request that Congress pass legislation to eliminate or restrict the timing of exchanges. Such language was included in the Deficit Reduction Act of 1984, restricting exchanges to 180 days and requiring that taxpayers identify what they want to receive in their exchange within 45 days of transfer of ownership.



Starker v. United States, 602 F.2d 1341, 1979 U.S. App. LEXIS 12252, 79-2 U.S. Tax Cas. (CCH) P9541, 44 A.F.T.R.2d (RIA) 5525 (United States Court of Appeals for the Ninth Circuit August 24, 1979)