Current Threats to a Hundred Year Old Tax Tool
by Suzanne Baker, EVP and General Counsel of IPX1031®
Terra Firma, the official publication of the REALTORS® Land Institute
Almost one hundred years ago, Congress enacted Internal Revenue Code 1031, permitting deferral of capital gains and recapture tax on like-kind exchanges. Two primary purposes of the tax were: 1) to avoid unfair taxation of ongoing investments in property and 2) to encourage active reinvestment. These purposes are even more relevant today in our global economy than they were in 1921. Download entire article PDF here.
Read the Terra Firma Winter 2017 Issue here.
Current Threats to a Hundred Year Old Tax Tool
‘Tis the season. To keep everything merry and bright, here are a few key 1031 updates and general reminders. Happiest of holidays from IPX1031®.
1031 End of Year Reminders
– Tax straddling may be a viable option for you if you are currently considering a 1031 Exchange. Read more. – December is the time when many people begin to think about giving. Avoid some common pitfalls in your generosity. Read more. – Tax Professionals: Protect Your Clients; Protect Yourself. Read more. – IRS, Partners Suggest Tips for Safe Holiday Online Shopping. Read more.
IRS Disaster Relief Updates
– North Carolina Disaster Relief Notice – Hurricane Matthew
– Minnesota Disaster Relief Notice – 9/21/16 Storms
1031 Tax Reform Update
The Republican Blueprint for Tax Reform poses threats to Section 1031 and Real Estate. Click here to read the latest update.Read More
With the newly elected Republican Congress and President, tax reform has been announced as a top priority, with a bill promised in early 2017. Speaker of the House Paul Ryan and House Ways & Means Chairman Kevin Brady have indicated that their plan is to move fast, before the business lobby opposition gets organized.
The Republican plan for Tax Reform is a radical rewrite of the tax code. It is an outline that is silent on many provisions. Surprisingly, Section 1031 still may be eliminated from the tax code.
We have asked Chairman Brady and other members of the committee how Section 1031 fits into the plan for tax reform. We received this alarming response, “With the income tax rate low enough and with immediate expensing for business equipment and real estate improvements, do we still need Section 1031?”
The answer is YES we still need Section 1031 because property owners cannot expense land. Also, most or all of the real estate gain is in the land and not the improvements. For example, farmers allocate approximately 90% of the value of their real estate investment in the land. In addition to the potential loss of Section 1031, the new Republican plan is already taking away the following tax deductions:
- Mortgage interest on investment property
- Transfer tax
- Personal property tax
- State income tax
- Real estate property tax
- Local tax
- Mortgage tax
- Other real estate related taxes
Real estate owners will be sorely disadvantaged and will see their investments shrink.
If you thought we were safe with a real estate guy in the White House, we are not. Congress is writing the bill. Once they pass it, President Trump will have to sign it.
TAKE ACTION #1 – CLICK HERE to send a letter to your congressmen and women. Even if you have previously sent letters, it is important to contact them again to tell them that Section 1031 must remain in the tax code.
TAKE ACTION #2 – Contact your National Real Estate Organizations and let them know how important Section 1031 is to you and your business.
If a taxpayer successfully completes a 1031 Exchange, major benefits include deferral of taxes and the ability to invest all of their equity. However, if a taxpayer is not able to purchase new property to successfully complete the 1031 Exchange, and the exchange fails, the taxes associated with the sale of their investment property will be due. Tax straddling may help with their immediate tax burden.
With “tax straddling” the taxpayer may receive a one year tax payment deferral thanks to the coordination between IRC §453 and §1031 provided in the §1031 regulations. Assuming a qualified intent, tax straddling provides added incentive to taxpayers to sell their relinquished properties near year-end to take advantage of the significant tax-deferral benefits of 1031 Exchanges with the one-year deferral benefits of §453 as a back-up plan.
How does this work? 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, since tax straddling does not apply to all sales and any gain attributed to debt relief will have to be recognized in the year of sale.
The IRS does not penalize investors for attempting to complete a 1031 Exchange. Tax straddling provides an added incentive to taxpayers selling investment property at the end of the year. Why not attempt to complete a 1031 Exchange when a one year payment deferral is available as the back-up plan?
Please call us at IPX1031® to discuss tax straddling and other valuable tax-deferral solutions, such as structured sale treatment, which can provide taxpayers unable to successfully complete exchanges with generous tax-deferral safety nets. Be sure to consult with your tax advisor to determine if you can take advantage of these valuable tax-deferral methods.
Houston Chronicle recently ran an Op-Ed by Randy Lee.
To our many friends and clients. We want to say thank you. Thank you for your business. Thank you for your trust, confidence and loyalty. Happy Thanksgiving from IPX1031®. May the good things of life be yours in abundance, not only at Thanksgiving but throughout the coming year.