Yesterday, elimination of Internal Revenue Code Section 1031 exchange was proposed by House Ways and Means Committee Chairman Dave Camp as a component of a nearly 1,000 page Discussion Draft for Comprehensive Tax Reform. If approved, the extensive changes would constitute a major overhaul of the complex U.S. tax system. Though the draft has not been proposed as a bill, it is destined for tax reform discussion most likely to be undertaken by Congress, possibly in 2015. Former Senator Max Baucus introduced a tax reform proposal last year that also includes the repeal of the 1031 exchange. Needless to say, the 1031 exchange regulation will be part of the intense discussion.
Section 3133. Repeal of like-kind exchanges
Current Law: Under current law, an exchange of property, like a sale, generally is a taxable transaction. A special rule provides that no gain or loss is recognized to the extent that property held for productive use in the taxpayer’s trade or business, or property held for investment purposes, is exchanged for property of a like-kind that also is held for productive use in a trade or business or for investment. The taxpayer receives a basis in the new property equal to the taxpayer’s adjusted basis in the exchanged property. The like-kind exchange rule applies to a wide range of property from real estate to tangible and intangible personal property. It does not apply, however, to exchanges of stock in trade, or other property held primarily for sale, stocks, bonds, partnership interests, certificates of trust or beneficial interest, other securities or evidences of indebtedness or interest, or to certain exchanges involving livestock or foreign property. A like-kind exchange does not require that the properties be exchanged simultaneously – as long as the property to be received in the exchange is identified within 45 days and ultimately received within 180 days of the sale of the original property, gain is deferred.
Provision: Under the provision, the special rule allowing deferral of gain on like-kind exchanges would be repealed. The provision would be effective for transfers after 2014. However, a like-kind exchange would be permitted if a written binding contract is entered into on or before December 31, 2014, and the exchange under contract is completed before January 1, 2017.
Consideration: The like-kind exchange rules currently allow taxpayers to defer tax on the built-in gains in property by exchanging it for similar property. With multiple exchanges, gains essentially may be deferred for decades, and ultimately escape taxation entirely if the property’s basis is stepped up to its fair market value upon the death of the owner.
The current rules have no precise definition of “like-kind,” which often leads to controversy with the IRS and provides significant opportunities for abuse.
Joint Committee on Taxation Estimate: According to JCT, the provision would increase revenues by $40.9 billion over 2014-2023.
The Federation of Exchange Accommodators (FEA) is an association governing and representing the interests of qualified intermediary members and actively lobbies legislators and government officials, voicing the benefits of the 1031 exchange. The FEA, along with approximately 40 industry groups, have provided comments to the Senate Finance Committee supporting the 1031 exchange provision.
The repeal of the 1031 exchange has been a topic of Congressional discussion for decades. In the past, the outcome of those discussions has been that the benefits of the 1031 exchange exceed the costs. There are many parts to the proposed tax reform that would fundamentally change and potentially simplify the tax code. As with the Simpson-Bowles deficit reduction plan, discussion is where the process begins. As to the outcome, time will tell.
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