updated May 2020
Across the US, 2016 was a record year the number of tax deferred exchanges and continued growth is expected for 2017. However the future of 1031 is uncertain with the new administration and Congress. Section 1031 of the tax code allows investors to sell a property, defer the taxes that would normally be due, and reinvest the proceeds into a replacement investment. This popular investment tool greatly enhances purchasing power and encourages taxpayers to continually invest in real estate. As we start this new year, here are some of the issues that will affect real estate and/or 1031 tax deferred exchanges.
Will You Pay Taxes in 2016 or 2017?
If a delayed 1031 Exchange begins in the latter portion of 2016, the exchange period may run into 2017. If the exchange fails or if the taxpayer (having a bona fide intent to do an exchange) receives cash boot in 2017, the 1031 regulations treat the exchange as an installment sale allowing the taxpayer to consider that the exchange proceeds were received (and are taxable) in 2017. However, in accordance with IRC section 453(d), a taxpayer may “elect out” of the installment method. By electing out, the taxpayer can recognize the gain in 2016 instead of 2017.
To elect out, the sale should be reported on Form 8949, Form 4797 (or both) and not on Form 6252. The election must be made by the due date, including extensions, for filing the 2016 tax return. For more information about the procedure and forms to use see IRS Publication 537 and consult with your tax advisor.
Taxpayers should consult with their tax advisors since tax straddling does not apply to all sales, and any gain attributed to debt relief will still have to be recognized in the year of sale.
“Drop & Swap” 1031 Exchange Disallowed in California
During the latter portion of 2016, the California State Board of Equalization (“SBE”) ruled against the taxpayers in In re Giurbino. The SBE is the appellate body for corporate franchise and personal income tax appeals in California. The main issue that was presented was whether the partners who did a 1031 exchange held the relinquished property for a qualified 1031 purpose (investment or business use).
In the case, a multi member LLC (which is treated as a partnership for income tax purposes) entered into an agreement to sell its real property and an escrow was opened under the name of the LLC. A few days before the transfer to the buyer, the property was deeded to the members of the LLC. Some of the members reported their share of the gain on their income tax returns; however the Giurbinos took the position they had completed a 1031 exchange.
In its ruling, the SBE held for the Franchise Tax Board and ruled that the LLC (not its members) was the seller of the property. Its apparent basis for this conclusion was a statement in the decision that at the time the property was deeded to the members of the LLC “the sale of the property was practically certain to be completed.” Accordingly, the members were essentially acting as agents for the LLC.
Most practitioners would counsel that the transfer of the property should be transferred to the members as far in advance of the sale as possible so the members can establish a qualified 1031 use as tenants in common. In addition, the transfer should be well in advance of any documents being signed that relate to the sale of the property. For more information on partnership issues, please click here.
1031 Tax Reform Update
Tax Reform is on the forefront of the new Administration’s agenda and 1031 Exchanges are still in danger of being repealed. A recent Chicago Tribute article, Tax reform could knock your real estate investment plans off track, illustrates the current situation and the timeliness of how changes could take place. Please send or re-send a letter to your congressmen via our website at www.ipx1031.com/action. The 30 seconds it takes to complete will truly go a long way in D.C.