<p>Tax deferral afforded through Section 1031 like-kind exchanges has been under threat of repeal or being reduction for many years. A committee made up members from the Senate Finance Committee and the House Way and Means Committee known as The Joint Committee on Taxation have made such recommendations many time over the past few decades. Cutbacks to Section 1031 had been recommended as far back as President Clinton’s administration. In 1997, that administration suggested requiring exchanges to be limited to “same-kind” properties rather than like-kind (any kind of real estate is like-kind to any other type of real estate). It came as no surprise that the recent House and Senate proposals for tax reform chose to whittle down Section 1031 in order to raise tax revenues to offset some of the tax reductions contained in the reform plans.</p>

<h2>The House Proposal</h2>

<p>The House proposal came out first and provided:</p>

<blockquote>
<p style="margin-bottom:.0001pt">“Under the provision, the special rule allowing deferral of gain on like-kind exchanges would be modified to allow for like-kind exchanges only with respect to real property. The provision would be effective for transfers after 2017.”</p>
</blockquote>

<p>What this means is that personal property exchanges such as those for machinery, equipment, vehicles, trucks, trailers, rail cars and aircraft would no longer be the subject of exchanges. Also, certain intangible property such as auto and other dealership rights and franchise rights were disallowed. Lastly, art and collectible exchanges were no longer allowed in this shift that amounted to allowing only real estate exchanges.</p>

<p>The House proposal made a note that:</p>

<blockquote>
<p style="margin-bottom:.0001pt">“The bill provides full expensing for most tangible personal property which provides a marginal effective tax rate of zero percent to fully expensed property, equating to the deferral that like-kind exchanges provide currently”.</p>
</blockquote>

<p style="margin-bottom:.0001pt">In aggregate, non-real estate exchanges currently represent a larger annual dollar volume than real estate exchanges. While arguments can be made that 100% expensing does not have as a significant benefit that tax deferral does under Section 1031, it certainly softens the blow to personal property. It does not help the other non-real estate asset classes that don’t constitute personal property.</p>

<h2 style="margin-bottom: 0.0001pt;">The Senate Proposal</h2>

<p>The Senate proposal was very similar and, after a summary of the current status of the various assets that can be the subject of exchanges, it concluded “This provision modifies the current law non-recognition of gains from like-kind exchanges by limiting its application to real property that is not held primarily for sale”.</p>

<p>Both the House and Senate proposals referenced a finding by the Joint Committee on Taxation that this change to Section 1031 is expected to save $30.5 billion over a ten-year period. It is worth noting that Ernst and Young prepared a study in 2015 in anticipation of the possible repeal of Section 1031 and came up with a somewhat opposite conclusion, due to the fact that repeal would make the turnover of assets less attractive. The study found “Repealing like-kind exchange rules would subject businesses that rely on these rules to a higher tax burden on their transactions, resulting in longer holding periods, greater reliance on debt financing, and less-productive deployment of capital in the economy.”</p>

<h2>The Final Bill: Tax Cuts and Jobs Act</h2>

<p class="MsoFooter">The final bill was signed into law on December 22, 2017. As expected, exchanges of real estate interests have been preserved while personal property assets are no longer exchangeable after January 1, 2018. The requirement for <a href="/blog/all-tax-deferred-exchange-companies-are-not-created-equal">the use of a qualified intermediary</a> (<a href="https://www.youtube.com/watch?v=Pi4l_dQgoh8&quot; target="_blank">Video: Who can and cannot act as a qualified intermediary in a 1031 exchange?</a>) has been retained under the tax reform bill.</p>

<p class="MsoFooter"><span style="text-decoration:none"><span style="text-underline:none">Further, as also expected, for any non-real estate exchanges begun prior to January 1, 2018, those may be still be completed in 2018. Real estate exchanges are as popular as they have ever been, and under Tax Reform they remain fully intact.</span></span></p>

<p>Excerpted from the <a href="https://www.bizjournals.com/denver/news/2017/11/01/viewpointbeware-chan… Business Journal</em>, "Beware changes in 'like-kind' transactions under proposed federal tax reform"</a>:</p>

<p><em>Rarely do the interests of small businesses owners and a broad range of local entrepreneurs agree with almost a century of federal income tax policy – especially when it results in billions of dollars in taxes being paid.</em></p>

<p><em>But luckily for the economy, they do.</em></p>

<p><em>The trouble is, this powerful economic driver is now in real danger as Congress and the Trump Administration grapple with the twin dilemmas of tax reform and a threadbare federal budget that would put such long-term investments and incentives at risk.</em></p>

<p><a href="https://www.bizjournals.com/denver/news/2017/11/01/viewpointbeware-chan…; target="_blank">Read Accruit CEO Brent Abrahm's op-ed at the <em>Denver Business Journal</em></a></p>

<p>The <a href="https://waysandmeansforms.house.gov/uploadedfiles/bill_text.pdf&quot; target="_blank">new tax bill unveiled today by House Republicans</a> proposes to repeal like-kind exchanges for personal property. In its place, the bill provides for 100% expensing of property, however this provision is only temporary, sun-setting after five years. 100% expensing may be extended, as other unrelated provisions have in the past, but the uncertainty makes long-term planning difficult for businesses. &nbsp;</p>

<p>As I have argued for years on the Hill, like-kind exchanges are a matter of tax timing and not a permanent deferral of taxes They give businesses in need of cash flow the strategic ability to determine when it is best to recognize gain and pay taxes associated with the disposal of capital assets.&nbsp; &nbsp;</p>

<p>Should Congress repeal like-kind exchanges, and provide for 100% expensing for five years, what will your company’s financial position be by 2024?&nbsp; Tax obligations will be high (states are not&nbsp; likely to adopt 100% expensing), there is no offset from capital expenditures, and the cost of debt, assuming the trend continues, will slowly cripple economic gain realized in prior years.</p>

<p>As illustrated in this table, immediate expensing increases cash flow for only three years under the proposed outline.&nbsp; In the fourth year, companies will begin to recognize significant increases in tax obligations.&nbsp; Should like-kind exchanges also be repealed, studies show that business will begin to contract – not expand -- in an environment in which cash flow is restricted.</p>

<p><img alt="" src="/sites/default/files/files/immediate-expensing-5-years-vs-lke.jpg" style="width: 800px; height: 393px;" /></p>

<p><a href="https://www.usa.gov/elected-officials&quot; target="_blank">Let your state and federal representatives know that immediate expensing not a fair trade for repeal of like-kind exchanges</a>.&nbsp; Your company relies on clients’ access to low cost debt, the ability to exchange assets (allowable under IRC 1031 like-kind exchanges), and incentives to deal in the secondary and tertiary markets. 100% expensing most likely would not include used equipment.&nbsp; This is not the way to grow our economy.&nbsp;</p>

<p>With so many weather-related natural disasters occurring with seemingly increasing frequency, let’s take a look at how such disasters affect persons seeking to complete exchange transactions. While the safe harbor timelines for conventional forward exchanges and for reverse exchanges are strictly enforced, there is some relief afforded in the event of a federally declared disaster in the form of time granted. The applicability of a particular federally declared disaster can be found on the IRS website, which provides <a href="https://www.irs.gov/newsroom/tax-relief-in-disaster-situations&quot; target="_blank">news releases covering disaster events</a>.</p>

<p>An IRS publication, IRS Revenue Procedure 2007-56 Section 17, sets forth the rules surrounding such disasters as they apply to forward and reverse exchanges. This revenue procedure states that the last day of the 45-day identification period, the last day of the 180-day exchange period for forward exchanges and the beginning and end dates for a reverse exchange can be extended. More specifically, those dates are postponed to the later of (i) 120 days or (ii) the last day of the general disaster period authorized in the IRS News Release. The revenue procedure further provides that in no event may a postponement period extend beyond (i) the due date for filing the tax return for the year of the transfer or (ii) one year. As a practical matter, should the due date for filing the tax return cut the postponement period short, the filing of an extension would lengthen the date to the full time period.</p>

<p>The revenue procedure further provides that a taxpayer qualifies for postponement only if the relinquished property in a forward exchange or the subject property in a reverse exchange have been transferred prior to the federally declared disaster and the taxpayer is (i) an “affected taxpayer” as defined in the applicable IRS News Release or (ii) the taxpayer has difficulty meeting the deadlines for any of the following reasons:</p>

<ul>
<li>The relinquished or replacement property are located in a covered disaster area as provided in the IRS New Release;</li>
<li>The principal place of business of any party to the transaction (e.g. qualified intermediary, exchange accommodation titleholder, settlement attorney, title company, lending financial institution) is located in the covered disaster area;</li>
<li>Any party to the transaction is killed, injured or missing as a result of the disaster;</li>
<li>A document prepared in connection with the exchange or a relevant land record is destroyed, damaged or lost as a result of the disaster;</li>
<li>A lender decides not to fund the closing due to the disaster or refuses to fund a loan to the taxpayer because, flood, disaster or other hazard insurance is not available due to the disaster or;</li>
<li>A title insurance company is not able to provide the required title insurance policy necessary to close a real estate transaction due to the disaster.</li>
</ul>

<p>The IRS revenue procedure also provides for a postponement to the last day of the 45-day period for applicable identification of property in a forward or reverse exchange if the identification was made prior to the federally declared disaster but the property was substantially damaged in the disaster event.</p>

<p>This is a summary of the rules pertaining to extensions to exchange transactions due to federally declared disasters. Before acting, taxpayers should reference the <a href="https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-…; target="_blank">IRS Disaster Relief Guidelines</a> and consult with a professional advisor.</p>

<h2>Recent Tax Relief for Disaster Victims</h2>

<p><a href="https://www.irs.gov/newsroom/help-for-victims-of-hurricanes-irma-and-ma…; target="_blank">Tax Relief for Victims of Hurricanes Irma and Maria</a></p>

<p><a href="https://www.irs.gov/newsroom/help-for-victims-of-hurricane-harvey&quot; target="_blank">Tax Relief for Victims of Hurricane Harvey</a></p>

<p><a href="https://www.irs.gov/newsroom/tax-relief-for-victims-of-wildfires-in-cal…; target="_blank">Tax Relief for Victims of Wildfires in California</a></p>

<p>United States tax code sections 1031 and 1033 are sometimes confused by taxpayers as they are similar, not only in section number, but in that they were both created to provide for tax deferral of depreciation recapture and capital gains on the sale of property, but that's where their similarity ends. <a href="/services/1031-exchange">1031 exchange</a> and 1033 exchange differ materially in:</p>

<ul>
<li>Types of transactions they address</li>
<li>Type of property that can be acquired</li>
<li>Timeline requirements</li>
</ul>

<h2>Section 1033: Involuntary Conversion</h2>

<p>Section 1033 of the tax code provides for the deferral of gain that is realized from an "involuntary conversion." Such a conversion includes property that is destroyed in a casualty, property that is lost due to theft and property that is transferred as the result of condemnation or the threat of condemnation.</p>

<h2>Section 1033: Direct and Indirect Conversions</h2>

<p>With a conversion into replacement property in a 1033 exchange, any gain related to the involuntary conversion is deferred if the conversion involves property considered similar in related service or use. That is, the use of the replacement property must be substantially similar to that of the relinquished property. This is considered a direct conversion. With a condemned property, the replacement property must be considered like-kind, a standard similar to that of Section 1031.</p>

<p>A 1033 conversion may also be indirect – with gain triggered on the amount converted into cash or dissimilar property. Partial deferral of gain in an indirect conversion is elective, and the taxpayer must take certain steps and meet certain criteria in order to defer gain in an indirect conversion. Most importantly, the cost of the qualifying replacement property must be equal to or greater than the amount realized at conversion. Falling short of the replacement cost will trigger gain recognition to the extent of the underinvested portion. Acquisitions from related parties can also trigger gain recognition.</p>

<h2>Section 1033: Timelines</h2>

<p>Generally, replacement property in a 1033 conversion must be acquired within two years of the end of the tax year in which the gain was realized, though some conversions can result in three, four and five-year replacement periods.</p>

<h2>1031 Like-Kind Exchanges</h2>

<p>Unlike 1033, tax code Section 1031 is specific to the voluntary reinvestment of gain from the sale of investment or business use property. In the case of a 1031 exchange, any gain related to the disposition of property is deferred if the replacement property is considered similar in nature and character. The quality or grade of the replacement property is of no consequence in a 1031 like-kind exchange, only that the property is of the same nature, character, or class. In fact, most real estate is considered like-kind to other real estate.</p>

<p>Gain recognition is triggered in a 1031 like-kind exchange if the cost of replacement property is less than the amount of gain from property that is relinquished. Gain recognition would also be triggered in the event that the taxpayer receives property that is not like-kind to the relinquished property. Finally, as in the case of a 1033 conversion, acquisitions from related parties can trigger gain recognition. Learn more about this in <a href="/blog/1031-tax-deferred-exchanges-between-related-parties">“1031 Tax Deferred Exchanges between Related Parties.”</a></p>

<h2>Section 1031: Timelines</h2>

<p>In order to defer gain in a <a href="/services/1031-exchange">1031 exchange</a>, the taxpayer must acquire like-kind replacement property by the earlier of 180 calendar days or the due date of the taxpayer's next income tax return.</p>

<h2>Summary&nbsp;Tax Code Sections 1031 and 1033</h2>

<p>Section&nbsp;1031 and 1033 are both powerful tax deferral strategies, but they differ substantially in their usage. Section 1033 is tax deferral specific to the loss of property by a taxpayer and is therefore is referred to as an involuntary conversion. Section 1031 is the voluntary replacement of real property in an exchange of business or investment assets. Finally, while Section 1031 generally requires the use of a qualified intermediary, Section 1033 does not.</p>

<p>In this episode of <a href="https://www.podomatic.com/podcasts/creshow/episodes/2017-09-20T14_20_31… Commercial Real Estate Show</a>, Michael Bull speaks with a panel of experts about tax reform and the likelihood of repeal of 1031 like-kind exchanges from the tax code. Michael is joined by:</p>

<ul>
<li>Evan Liddiard, Senior Policy Representative at the National Association of Realtors</li>
<li>Robert Carroll, National Director of Ernst and Young's Quantitative Economics and Statistics practice</li>
<li>David Ling, Director of Real Estate at the University of Florida's Warrington College of Business</li>
<li>Accruit Founder/CEO and Federation of Exchange Accommodators Government Affairs Committee Co-Chair, Brent Abrahm</li>
</ul>

<p>This timely discussion occurs on the eve of the unveiling of the Republican framework for tax reform by the Trump Administration, the House Ways &amp; Means Committee, and the Senate Finance Committee. <a href="https://www.podomatic.com/podcasts/creshow/episodes/2017-09-20T14_20_31… to the show.</a></p>