Another check-in with Section 1031 like-kind exchanges

In past newsletters, our attorneys have discussed the opportunities provided by Section 1031 of the Internal Revenue Code, better known as the section of the tax code that permits “1031 exchanges” or “like-kind exchanges” of real property used for business or investment purposes. Given that Tax Day 2022 is soon approaching and the Biden Administration released its Fiscal Year 2023 budget plan this week, any person or company considering selling real estate used for productive or investment purposes will want to assess the potential tax consequences of utilizing like-kind exchanges and the impact of some of the proposed changes to the tax code.

To refresh or introduce the concept of a like-kind exchange, they can be explained as follows: normally when a business or investment property (which are considered “like-kind” under the section) that has appreciated in value is sold, a tax is assessed on the gain. Under Section 1031, taxpayers are allowed to “exchange” like-kind real properties for other like-kind properties and rather than paying taxes on the proceeds, they are allowed to defer the recognition of taxable gains until a later recognition event, so long as certain requirements are met.

The basic requirements are:

• Before, or along with, the disposition of the real estate, the taxpayer enters into an exchange agreement with a “qualified intermediary,” which is either a person or company that agrees to hold the funds of the transaction until they can be transferred to the seller of the replacement property.

• Upon closing, the proceeds from the sale are deposited with the qualified intermediary.

• Within 45 days of the date of closing, the taxpayer must identify one or more replacement properties.

• The taxpayer must then purchase one or more of the identified replacement properties within 180 days of the date the relinquished property is sold. When the replacement property or properties are acquired, the money held by the qualified intermediary is used to purchase the replacement property.

Last year, the Biden Administration moved toward limiting the amount of gain that can be deferred in a like-kind exchange to $500,000 per taxpayer – meaning any gains from like-kind exchanges in excess of $500,000 a year would have to be recognized by the taxpayer in the year of the exchange – whereas there is currently no such limit in place. However, both the House and the Senate opted not to implement any changes to Section 1031. In the Administration’s 2023 budget, many of the same proposed changes to the tax code were again put forward, including the proposal that would limit the deferral of gain up to an aggregate amount of $500,000 per taxpayer. While it has yet to make it through the appropriate Senate or House committees for review, the proposed change would be effective for exchanges in taxable years beginning after December 31, 2022.

Section 1031 exchanges are not limited to institutional investors. In recent years, there has been a gradual increase of smaller firms and individuals taking advantage of these tax deferrals. There are many robust markets across the country and the gains from selling small apartment buildings, single-family rentals and other business or investment properties are being applied to new acquisitions.

Our real estate attorneys will continue to follow any developments that would alter like-kind exchanges. If you are considering selling real estate that you own that operates for productive purposes in a business or trade or serves as an investment property, please consider contacting a Chuhak & Tecson real estate attorney to discuss opportunities that may be available to defer a tax on the gain.

For more information contact Kevin Coyne(312 855 5441), principal and Real Estate practice group leader.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.