Tax-deferred exchanges gained additional momentum when Congress adopted The Tax Reform Act of 1986, which eliminated preferential capital gains treatment, disallowed deductions for passive losses and eliminated accelerated depreciation. These restrictions made it unpopular for real estate investors to hold on to losing assets. As a result, 1031 exchanges into better quality properties emerged as one of the few tax-friendly options left for real property investors.
Further spurring the popularity of 1031 exchanges was IRS Revenue Procedure 2002-22, enacted in 2002, which allowed tax-deferred exchanges for "tenancy in common" or "TIC" property transactions. Now 1031 exchanges were permitted not just for single-owner properties but also for multiowner, professionally managed real estate assets.
The heated real estate market and easy lending of the early and mid-2000s created a hot market for 1031s. Between 2003 and 2008, Section 1031 investors poured more than $12.5 billion into various multiowner TIC properties ranging from shopping centers, office buildings, industrial buildings, apartments, and free-standing assets, according to Omni Real Estate Services.
Then in 2009, in the thick of the nation's financial turmoil, the bottom of the real estate market fell out. Investors scrambled to protect their equity in free-falling investments while lenders went out of business in record numbers. With no available liquidity to fund like-kind property purchases, the 1031 market came to a screeching halt.