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For certain entrepreneurs, investors, and other development-minded individuals, Section 1031 is an extremely important aspect of the Internal Revenue Code. Through Section 1031, certain taxpayers can secure tax relief that permits capital that would otherwise be tied up in paying taxes to be utilized for further development or entrepreneurial purposes. Section 1031 of the Tax Code is a pro-economic growth provision commonly utilized by builders, developers, and others.
Unfortunately, the recently proposed GOP House of Representatives Tax Reform plan does not seem to account for this provision of the Tax Code. In fact, many tax and financial advisors are now concerned that the plan will eliminate this form of tax relief. If the Section 1031 like-kind transfer is eliminated, it is likely that numerous businesses will be impacted. Businesses that may have planned to utilize such a transfer may be disrupted by the entity’s inability to defer taxes on capital gains realized through property transfers. As such, businesses should begin to explore options regarding expediting transfers or transactions or make alternate tax planning arrangements. An experienced Tax Lawyer, CPA, or tax professional from the Tax Law Offices of David W. Klasing can help.
Typically, when a business sells or transfers property, it will realize a taxable capital gain or loss. When there is gain, the tax will ordinarily be accounted for and come due at the time of the sale or transfer. Thus, absent tax relief, businesses and taxpayers who transfer property and realize a gain will pay tax on that gain. This means that less capital from the sale would typically be available for reinvestment or other business purposes.
Like-kind exchanges under Section 1031 of the Tax Code permit a business or investor to defer the tax impact of capital gains. This deferral of the capital gains tax will generally encourage reinvestment into productive uses that may lead to new facilities, capabilities, and growth. To be clear, a Section 1031 transfer does not permit tax-free treatment, but it can significantly delay when a capital tax obligation comes due.
Both real property and personal property can qualify for a Section 1031 exchange, but because property must be like-kind, one cannot swap real property for personal property or vice-versa. The like-kind property must be of the same nature, character or class however quality or grade of the property is irrelevant to the analysis. It is also important to note is that like-kind requirements are more rigorous for personal property than they are for real property. For these and other reasons, real estate developers are some of the most common users of the Section 1031 tax deferral provision.
According to tax observers who have read and assessed the House of Representative’s draft tax reform plan which was released last year, there is no mention of 1031 exchanges or like-kind swaps. At least some observers have speculated that this was not an omission but rather an intentional choice to jettison the tax relief provision.
There is some support for this view. To start, one of the chief stated goals of the tax reform plan is to “simplify” the U.S. Tax Code and bring clarity to tax obligations for individuals and businesses. Attempts to accomplish this goal generally include reducing marginal tax rates while also closing or closing tax “loopholes” which roughly translates to eliminating certain tax deductions, credits, and deferral options. Another justification for the removal of more complex tax options is the fact that many lobbyists expect proposed marginal tax rate cuts to eliminate the need for tax relief options of this type.
Despite the inferences and projections drawn by analysts, there is still hope that the 1031 tax deferral mechanism will be retained. Chiefly, this stems from the fact that the 1031 exchange is typically utilized by property developers and other entrepreneurs. As most people are aware, the President Trump is a real estate developer who utilized Section 1031 transfers to fund the development of high-rise towers. Similarly, President Trump’s son-in-law, Jared Kushner’s, family business is also in real estate development. While Congress has the final say on the Tax Code, the executive and Congress are controlled by the same political party. As such, a possibility exists that Congress might work with the president to retain Section 1031 like-kind transfers.
If you or your business or organization was considering a 1031 like-kind swap, news of its potential elimination may make future development goals less likely to be achieved or impractical. However, it is essential to note that the tax reform bill is not yet law and there is still time for your company or organization to reap the benefits of a like kind-transfer. However, additional delay can reduce the likelihood that your transfer or transaction will be completed before reform efforts potentially eliminate like-kind transfers.
The lawyers and CPAs of the Tax Law Offices of David W, Klasing can work with your business to strategically and expeditiously plan a tax-deferred Section 1031 transfer. To schedule a reduced rate, confidential initial consultation at the Los Angeles or Irvine Tax Law Offices of David W. Klasing dial 800-681-1295 or schedule online today.
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