1031 Like-kind Exchanges: How the Treasury Revenue Proposals could affect the deferred gain[1]
What is the Current Law?
When owners of appreciated property that is used in a trade or business or is held for investment decide to exchange such real property for other property of a “like-kind” then the tax on the gain from the exchange is deferred until a later recognition event occurs. The “like-kind” replacement property must also be held either for productive use in a trade or business or for investment. Any realized gain will be recognized to the extent of boot—which is the sum of money, including net liabilities assumed or attached to the property, received and the fair market value of any nonqualifying property received.[2] Further, any gain realized on a §1031 “like-kind” exchange must be recognized to the extent that such gain is subject to recapture under §1245 and §1250.[3] In the case of any loss realized on a §1031 “like-kind” exchange, such loss will not be recognized even if any boot is received.[4] Even though §1031 may not be elected or waived, nonrecognition can be avoided by intentionally falling outside the statutory requirements of §1031.[5]
Any real property received by the taxpayer in a §1031 exchange is treated as “like-kind” if (1) the replacement property is “identified as the property to be received . . . on or before the day which is 45 days after the date on which the taxpayer transfers the property” to be relinquished in the exchange; and (2) the replacement “property is received after the earlier of (a) the 180th day after the date on which the taxpayer transfers the property to be relinquished, or (b) the due date for the taxpayer’s return for the taxable year in which the transfer of the relinquished property occurs.”[6]
What are the changes proposed by the Treasury?[7]
Currently, there is no cap on the amount of gain that may be deferred. However, the proposed changes would limit the aggregate amount of deferred gain to $500,000 for each taxpayer ($1 million for married taxpayers filing a joint return) each year for §1031 real property “like-kind” exchanges. For any gains in excess of the cap ($500,000, or $1 million if joint return), such gain would be recognized in the year the taxpayer transfers the real property subject to the exchange. The proposed changes would ultimately treat §1031 “like-kind” exchanges of property used in a trade or business or held for investment more similarly to sales of real property to result in fewer distortions and align the treatment of real property with other types of property.
The proposed changes, if enacted, would become effective on January 1, 2023. Taxpayers planning to do a §1031 “like-kind” exchange by end of 2022 may want to consider the impact of the proposed limitations on gain deferral and the effect on whether such taxpayer’s potential exchange will meet the current §1031 requirements for identifying and exchanging properties before the end of 2022.
[1] General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals (treasury.gov).
[2] Portfolio 567-5th: Tax-Free Exchanges Under Section 1031, II. Statutory Requirements, A. In General (bloomberglaw.com).
[3] Id.
[4] Id.
[5] Id.
[6] Id.
[7] See General Explanations of the Administration’s Fiscal Year 2023 Proposed Regulations, supra note 12.