Since its inception as part of The Revenue Act of 1921, many real estate investors have reaped the benefits of the “like-kind exchange.” Over the years, the provisions of the current Internal Revenue Code Section 1031 have seen several changes both as a result of additional regulations issued by the Treasury Department as well as courts decisions at varying levels.
At its core, the like-kind exchange is intended to allow taxpayers to defer taxable gain recognition with respect to property (with certain exceptions) held for business or investment if exchanged for property held for business or investment of a like kind. While the name may imply a trading of similar properties, the like-kind exchange does not require properties to be exchanged simultaneously, so long as the replacement property is identified within 45 days and obtained within 180 days of the sale of the relinquished property and the funds from the relinquished property are held by a qualified intermediary.
In recent years, the fate of the like-kind exchange has been uncertain. In 2014, the former Ways and Means Committee Chairman Dave Camp released a discussion draft of the Tax Reform Act of 2014 that called the complete repeal of the like-kind exchange. The rationale for this proposal was that the like-kind exchange allows multiple consecutive exchanges enabling taxpayers to defer (and at times ultimately avoid though a basis step-up) taxation on the disposition of property. An additional stated concern was that the current rules do not have a precise definition of “like-kind,” which often leads to controversy with the IRS and potential abuse. Ultimately, this act never gained much traction, so the like-kind exchange continued.
More recently, in 2016 the current Ways and Means Committee Chairman Kevin Brady proposed a tax reform blueprint commonly referred to as “A Better Way.” While the proposal did not specifically address the like-kind exchange, many experts believed that the plan’s provisions for immediate full expensing of business and investment property (including buildings but excluding land) would effectively end the like-exchange if enacted. Like the full repeal included in aforementioned Tax Reform Act of 2014, the full expensing provisions included in the blueprint have ultimately been abandoned.
As we approach the end of 2017, at the time of writing, there exists two viable tax reform plans. The House of Representatives and the Senate Finance Committee have both released versions of the “Tax Cuts and Jobs Act.” While the like-kind exchange has historically been applicable to both real and personal property (as determined under state law), both the House and Senate versions of tax reform intend to limit like-kind exchanges after 2017 to real property. While there are certainly taxpayers who will not be pleased with this change, for real estate investors, this is welcome news given the uncertainty over the past few years.
Please consult your tax adviser to determine how tax reform may impact your specific situation.
Joel A. Bock, CPA, MST is a partner in Daniells Phillips Vaughan & Bock, a Bakersfield accounting firm.