Home » Near and Long-Term Tax Planning for Section 1031

Near and Long-Term Tax Planning for Section 1031

Lots of questions continue to swirl around the state of like-kind
exchanges (real estate in particular) both in the near and long-term.
As a tax planner, it’s best to look at the current legislative impact
and the possibilities. Mike Pusey, CPA offers his perspective.

The IRC Section 1031 “landscape” has narrowed significantly and may be
further restricted, but is likely to remain a critically important
element for tax planning purposes.

Even in a more tax-friendly administration, we saw some deterioration
in like-kind exchange planning with the exchange of personal property
being removed from the scope of Section 1031. The Tax Cuts and Jobs
Act generally removed personal property from qualifying for like-kind
exchange treatment after 2017.

Interestingly, the only pronouncement one finds in the IRS “PLR bank”
dealing with section 1031 during the Biden administration focuses on
personal property. To research non-precedential private letter rulings
by code section or subject, see this site:
irs.gov/written-determinations.

We find a Chief Counsel Memorandum holding that pre-2018 exchanges of
certain types of cryptocurrencies did not pass muster as like-kind
exchanges. (PLR 202124008, 6/18/21.) The pronouncement’s discussion
emphasizes “character”:

“Treas. Reg. § 1.1031(a)-1(b) defines “like-kind” to mean the nature
or character of the property and not the grade or quality. One kind or
class of property may not be exchanged for property of a different
kind or class. For example, an investor who exchanged gold bullion for
silver bullion was required to recognize gain in part because silver
is primarily used as an industrial commodity while gold is primarily
used as an investment. Rev. Rul. 82-166. Similarly, an investor who
exchanged one kind of gold coin for another kind of gold coin was
required to recognize a gain because one coin’s value was derived from
its collectability while the other’s value was derived from its metal
content. Rev. Rul. 79-143.”

The focus was pre-2018 because post-2017, personal property exchanges
are by statute outside of the scope of tax-free treatment under
Section 1031. As tax professionals, we realize tax-free treatment
usually comes at a cost – low, carryover basis in the received
property. To the extent, that the deferral translates into an eventual
step-up in basis at death, the “deferral” becomes tax savings, usually
permanent, federal, and state.

The author’s best guess is compliance, which may be relatively poor,
but keep in mind that exchanges of business machinery, including
ordinary trade-ins, are now taxable exchanges. As noted in the
following, it is possible that taxable disposition treatment, rather
than like-kind exchange treatment, may mean deductible losses.

“With no § 1031 treatment available to personal property in 2018,
equipment or livestock ‘trades’ will be treated as taxable events,
with the taxpayer computing gain or loss based upon the difference
between the amount realized on the sale of the relinquished asset and
the party’s adjusted basis in the asset. “Amount realized” includes
any money, as well as the fair market value of the property (other
than money) received in the transaction. There will be no tax deferral
for §1231 gains or §1245 recapture. There will also be no deferral for
a loss.” (“How Does the New Tax Law Impact Equipment

Trades?” Tidgrin, Ag Docket, Perspective on Agricultural Law and
Taxation, Center for Agricultural Law and Taxation, 1/16/18).

Realty

With the narrowing of the scope of the like-kind exchange benefit, we
find real property now being defined, at least for this purpose. See
generally the definition of reality for purposes of Section 1031 under
relatively recent final regulations. (T.D. 9935, published 12/2/20, as
corrected 2/22/21, 86 FR 10457.)

Realty remains the Section 1031 exchange emphasis. For example,
co-ownership in some fashion arises frequently with a disparity in the
goals of the real estate owners, some wanting to exchange with the tax
deferral benefits of Section. 1031.

Section 1031 and co-ownership when only some owners want tax-free
exchange treatment can involve such planning as transitioning out of a
partnership interest into direct ownership, or even the introduction
of multiple partnerships. There are also important Section 1031
considerations with property tax. See “Three Important Areas for 2020
Year-End Tax Planning,” Rojas & Associates, CPAs, 9/30/20,
rojascpa.com “Articles” section of the site, “Real Property Taxes”
section of the article.

Comparisons of Section 1031 and reinvesting gains in qualified
opportunity zones are a current topic of discussion. (“Case Study:
1031 to OZ Investment, with Lawrence Jasek,” Opportunity Db, the
Opportunity Zones Database, 7/13/22.)

Planning Environment

The topic of realty and related parties may generally take on added
importance in what may be significant changes in the tax environment –
e.g., more concern with gains taxation and transfer taxes. Section
1031 real estate exchanges among related persons may be possible. (See
PLR 202053007 (12/31/20)).

Discussions have taken place in affected industries warning that the
elimination of like-kind exchanges altogether, would hurt the economy.
According to a 2020 study, It would “disrupt many local property
markets, harm both tenants and owners, and would push offshoring
business activity.” (Study by the

Real Estate Research Consortium, “Possible Impact of Repealing or
Limiting 1031 Exchange,” SRS Real

Estate Partners, srsre.com).

The emphasis in the Biden proposals is more taxable realty
transactions without eliminating Section 1031 altogether. Rather
President Biden’s emphasis is on limiting the traditional benefits of
Section 1031 in real estate, specifically limiting it to gains that
exceed $500,000. All the details of the Biden proposal are not on the
table so our discussion is from a general perspective.

For example, in planning for a $500,000 limit, when will we know for
sure that the limit will work in a related party context? Moreover,
what if there is a gift of realty to family members then the family
member has near-term 1031 transfers? How then is there a $500,000
limit, if there is a tax-free transfer into a controlled corporation
followed by the corporation’s Section 1031 transfer? (Sec. 351).

Early reports are that the Section 1031 limits would not apply to C
corporations, including closely-held corporations. (See “The Biden
Administration Proposes Changes to the Taxation of Real Property,”
Corn, Friedman, Hamilton, Miller, Nussbaum, Roscow and Halabi, Tax
Talks the Proskauer Tax Blog, 5/11/22, proskauertaxtalks.com. See also
their discussion of Biden’s realty depreciation recapture provisions).

There is an important 180-day rule when a qualified intermediary is
involved in the Section 1031 exchange (Sec. 1031(a)(3)). The following
quote is under the heading, “Like-Kind Exchanges Using Qualified
Exchange Accommodation Arrangements,” in IRS Pub. 544, “Sales and
Other Dispositions of Assets,” for use in preparing 2021 returns.

“The like-kind exchange rules do not generally apply to an exchange in
which you acquire replacement property (new property) before you
transfer relinquished property (property you give up). However, if you
use a qualified exchange accommodation arrangement (QEAA), the
transfer may qualify as a like-kind exchange. For details, see Revenue
Procedure 2000-37, 2000-40 I.R.B. 308, as modified by Revenue
Procedure 2004-51, 2004-33 I.R.B. 294.

Under a QEAA, either the replacement property or the relinquished
property is transferred to an exchange accommodation titleholder
(EAT), who is treated as the beneficial owner of the property.
However, for transfers of qualified indications of ownership (defined
later), the replacement property held in a QEAA may not be treated as
the property received in an exchange if you previously owned it within
180 days of its transfer to the EAT. If the property is held in a
QEAA, the IRS will accept the qualification of property as either
replacement property or relinquished property and the treatment of an
EAT as the beneficial owner of the property for federal income tax
purposes.”

As the author writes in July 2022, one’s Section 1031 tax planning
perspective might contemplate timing the 180-day period such that the
transaction terminates either in 2022 or early 2023. If President
Biden’s proposals do get enacted to severely limit the gains eligible
for Section 1031 tax-free exchange treatment, any enactment date might
be relatively near-term.

But what about the effective date? What specifics might one find in
the details of any new law as it describes transactions subject to new
limitations? And how will the wording of any effective date affect the
180-day rule in the near term?

Early reports of Biden’s proposal are limited to gains from
transactions completed after 2021, but what may be the eventual date
and its specific terminology given the extensive delays?

Will the measure of Section 1031 retention be limited to $500,000 or
$1 million on a joint return per year, or will early reports be
modified?

In Conclusion

The environment is one of the very significant Biden proposals
affecting real property being delayed if not waning, or being subject
to major change. Yet our current environment is generally one of
increased emphasis on higher taxation, including such particulars as
the emphasis on carryovers versus the traditional carryback.

If the Biden concept of limiting Section 1031 realty exchanges to
benefit only the year’s transactions within certain gain limits, the
prospect is one of taxable gain, tax due in cash, yet the asset
received was realty, which the tax collector (usually) doesn’t want.
Plus, any mitigation of such tax with a carryback arising from next
year’s NOL is less of a factor.

“For most taxpayers, NOLs arising in tax years beginning after 2020
can only be carried forward.” (“Net operating losses,” IRS.gov,
irs.gov/newsroom/net-operating-losses.)

The latest mid-July reports of tax-increasing provisions in the Senate
don’t mention our like-kind exchange topic. (“Senate Democrats make
progress with reconciliation package,” Pittman, Wronsky, Dillon,
Hobbs, Schiavo, Bakertilly Tax Alert, 7/12/22;
https://www.bakertilly.com/insights/senate-democrats-make-progress-with-….)

But if pressures should result in near-term reality exchanges
significantly triggering taxable gains, the partial repeal of
like-kind exchange treatment will be a primary focus in a warning and
educating clients.

Like-kind, tax-free exchange of realty is imminently fair and
hopefully will remain with us, despite legislative proposals to the
contrary. If such a measure does arise, many of the tax professional’s
clients will need education and new planning.

In the author’s opinion (best guess), the prospects of such a major
change are less than likely, but certainly, a possibility that may
accelerate near-term planning under existing rules.

Leave a Reply

Your email address will not be published.