Like Kind Exchanges

Like-kind exchanges — when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” — have long been permitted under the Internal Revenue Code.  Generally, if you make a like-kind exchange,  you are not required to recognize a gain or loss under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received. You can’t recognize a loss.

Under the Tax Cuts and Jobs Act, Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property. An exchange of real property held primarily for sale still does not qualify as a like-kind exchange. A transition rule in the new law provides that Section 1031 applies to a qualifying exchange of personal or intangible property if the taxpayer disposed of the exchanged property on or before December 31, 2017, or received replacement property on or before that date.

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What Are Like-Kind Exchanges?

In the event that an investor should be involved with a sale or exchange of real estate, it is critical to understand the benefits and scope of “Like-Kind Exchanges.” Generally, the sale and exchange of property is a taxable event. However, under Section 1031 of the Internal Revenue Code, an investor may qualify for the taxable gain from the exchange to be deferred indefinitely.

Prior to the passage of the “Tax Cuts and Jobs Act of 2017” (otherwise known as the GOP Tax Plan or the Tax Reform Bill), both personal property and real property exchanges were granted the tax-deferred treatment. The new law now limits the deferral treatment for exchanges involving only real estate transactions.

The scope of permissible tax-deferred exchanges is very broad, including the exchange of an apartment building for a vacant lot. However, like-kind exchanges generally do not apply to primary residences and vacation homes. They only apply to exchanges of real property held for the purpose of investment or for productivity use or used in a trade or business. In addition, the property received in the exchange must also be held for the same or similar purpose. Our firm can help an investor decide whether a like-kind exchange is suitable to his or her circumstances.

Why Are Like-Kind Exchanges Beneficial To Investors?

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The New York Times Editorial Board has written an editorial condemning tax breaks, which is justified, in part. They point out:

Tax breaks work like spending. Giving a deduction for certain activities, like homeownership or retirement savings, is the same as writing a government check to subsidize those activities. Functionally, they mimic entitlements. Like Medicare, Medicaid and Social Security, they are available, year in and year out, in full, to all who qualify. Yet in budget talks, Republicans ignore tax entitlements, which flow mostly to high-income taxpayers, while pushing to cut Medicare, Medicaid and Social Security.

While they point out that the deduction for homeownership is the same as writing a government check they go on and only point out the special deductions/entitlements they feel are the ones the rich take advantage of:

CARRIED INTEREST.   This loophole lets private equity partners pay tax on most of their income at a top rate of 20 percent, versus a top rate of 39.6 percent for other high-income professionals. It drains the Treasury of $13.4 billion a decade, and should be closed, along with a shelter recently enacted in Puerto Rico that would help shield the income of individuals whose taxes would rise if the carried-interest tax break was eliminated.

NINE-FIGURE I.R.A.’S.   Remember Mitt Romney’s $100 million I.R.A? Private equity partners apparently build up vast tax-deferred accounts by claiming that the equity interests transferred to such accounts from, say, their firms’ buyout targets are not worth much. No one knows how much tax is avoided this way. What is known is that I.R.A.’s are meant to help build retirement nest eggs, not to help amass huge estates to pass on to heirs.

‘LIKE KIND’ EXCHANGES.   As reported in The Times by David Kocieniewski, this tax break was enacted some 90 years ago to help farmers sell land and horses without owing tax, as long as they used the proceeds to buy new farm assets. Today, it is used by wealthy individuals and big companies to avoid tax on the sale of art, vacation homes, rental properties, oil wells, commercial real estate and thoroughbred horses, among other transactions. Government estimates say this costs about $3 billion a year, but industry data suggest the amount could be far higher.

While these entitlements, which can be abused egregiously,  they are not the only ones. What Congress really needs to do is discard the entire tax code except for §61 which defines income as:

Except as otherwise provided in this subtitle, gross income means all income from whatever source derived …

Starting with that clean slate they should only allow exceptions for those exceptions which are willfully, intelligently and fully understood when put in place. No passing them so we can read the bill later.

These exceptions to income should be subject to hard and fast sunset provisions with the continuing of the exceptions only after detailed review and assessment that the purpose for which it was provided still is valid.

The tax code should not be used for social policy reasons. Examples are numerous but some of them are:

1.  Education Credits – to promote higher education for a certain group of citizens … discrimination to “fix” discrimination.

2.  Earned Income Credit – the largest area of fraudulent returns.

3.  Child tax credits … paying people who cannot afford to have children to have children.

4.  Mortgage Interest Deduction … started with the tax code of 1952 to help enable the returning veterans buy homes … something Congress deemed a good social goal.

5.  Child Care Credit … to allow single mothers the ability to work … a worthy cause I am sure but one that does little to discourage out of wedlock children, single parent homes, latch-key children, the cycle of children who are brought up thinking this sort of life style is appropriate.

Some will think I am harsh by the entitlements that I point out. I am not trying to say that none of them are valid I am just arguing that there should be no sacred cows. No matter which section of the tax code you try to eliminate someone’s ox is being gored. It is time to start over with the clean slate.