A tax accounting regulation that lends liquidity to commercial real estate investing is still on the chopping block: The Senate Finance Committee under Sen. Max Baucus, D-Mont., wants to do away with 1031 tax-free, like-kind property exchanges.
Section 1031 of the Internal Revenue Code allows exchanges of certain types of investment property with deferred capital gains taxation if the replacement property is identified within 45 days of the close of escrow on the old property and if title is taken on the new property within six months.
“Like-kind” is defined loosely: pretty much any kind of property held as an investment can be traded for any other kind of property to be held as an investment: Land for an office building, for example.
Serious talk of repealing the tax break started more than a year ago as tax reform discussions kicked up in Congress. Most recently, repealing Section 1031 was part of a package of proposals from Baucus released Nov. 21.
Tax can be deferred in a series of transactions, carried over to each asset until a taxable transaction occurs, which means a sale without reinvestment. The exchanges became easier with an IRS ruling in 2000: Before, relinquished property had to be sold before the purchase of the replacement property for tax deferral to be guaranteed.
The thinking behind the regulation, which apparently dates to the 1920s and intended to shelter farmers swapping livestock and land, is that no economic gain has been achieved — that value has just been relocated.