1031 Exchanges in Danger of Being Repealed!
A 1031 exchange, which is one of the driving forces of our nascent and fragile economic recovery, is in serious danger of being eliminated. Using pejorative terms such as “loop hole”, “fairness”, and “tax neutrality”, the government is seeking to eliminate one of the greatest economic drivers of the past hundred years. That’s correct – in one form or another the ability to defer capital gains tax when selling business or investment real property has been around for almost one hundred years.
When will such potential changes take effect? With the upcoming election in November, and changes to some of the committee membership, it is unlikely the government addresses tax reform this year.
Before you think this is a screed against a single political party you need to continue reading. The Republicans and Democrats are joining forces to collectively load the gun that will shoot our economy in the foot. The White House, a House Ways and Means bipartisan working group, the Senate Finance Committee, and the Joint Committee on Taxation all have their own recommendations on eliminating or severely restricting IRC §1031 tax deferred exchanges.
But all is not lost! Should the government decide to consign 1031 exchanges to the economic trash can, taxpayers will inevitably took to other tax strategies to structure their transactions to help defer the capital gains tax. One 1031 alternative method in use today, and not part of repeal efforts by the government, is the use of a structured installment sale. A structured installment sale utilizes section 453 of the Internal Revenue Code to allow for the investment of the pre-tax lump sum received from the sale of property. And unlike a 1031 exchange a structured installment sale can be used for a variety of assets including primary residences, business, and personal use property. It is not limited to the sale of business or investment property.
In short, section 453 of the Internal Revenue Code provides taxpayers the ability to defer capital gains tax from the sale property until they actually receive the funds. For example, if an investor sells a property for one million dollar, and agrees to accept a two hundred thousand dollar payment in year one and equal payments over the next nine years, that taxpayer will only have to pay capital gains tax on the principal payment they receive each year.
A structured installment sale works similar to a 1031 exchange in that the funds from a sale are collected by a third party to be used toward the purchase of “replacement assets”. But instead of using the funds to buy real estate a structured installment sale normally involves the purchase of annuities, stocks and/ or bonds.
In conclusion, a structured installment sales currently provides an underutilized method of deferring capital gains tax, but it may become the “only game in town” should the government repeal section 1031 of the Internal Revenue Code.