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TAX

Sec. 1031 may not be a viable gains rate today of 23.8% for high-income earners

option for high-income taxpayers (20% long-term capital gains rate plus 3.8% net
investment income tax). Under the American Fami-
in the future, given the current lies Plan, when the 3.8% net investment income
tax is added to the proposed maximum long-term
political climate. capital gains rate, high-income earners would
pay as much as 43.4% on long-term capital gains.
Although the details of the proposed changes are
still taking shape as of this writing, increased taxes
are expected on both earned and capital income.
period of time, depreciation recapture can be a huge
consideration in the sale/reinvestment decision, LIKE-KIND EXCHANGES: OWNERSHIP,
since the tax owed on recaptured depreciation may DEADLINES, AND OUTCOMES
be as much as or greater than the overall capital Planning, preparation, and execution of a like-kind
gains tax. Deferral of taxation in a reinvestment exchange is a very rules-based endeavor. Taxpayers
situation is in keeping with a long-held sentiment and their advisers must be aware of potential pitfalls
that taxes should be collected when taxpayers have that can derail any attempt to accomplish a tax-
the wherewithal to pay. If the proceeds from the deferred swap of properties. For example, if taxpayers
sale of an investment property are being reinvested, fail to identify replacement properties in a timely
the taxpayer may not have the wherewithal to pay manner, or if the proceeds from the relinquished
income taxes. property are not properly handled by an independent
President Joe Biden has proposed numerous third party, an intended like-kind exchange may be
changes to the tax code that would significantly af- treated as a sale and subsequent purchase for tax
fect investors who are making the sale/reinvestment purposes. The following issues must be addressed
decision. As of this writing, Congress is considering when structuring a Sec. 1031 exchange.
major tax reform, and one of the many proposed
changes is a limitation on the amount of gain that Issue No. 1: What is ‘like kind’?
may be deferred in a reinvestment situation. Spe- It is important to keep in mind that, for purposes
cifically, Biden has proposed limiting capital gain of Sec. 1031, gain deferral is only applicable to
deferral in a like-kind exchange to a maximum of property that is of “like kind.” A taxpayer’s primary
$500,000 ($1 million for married individuals filing residence does not qualify for this type of tax treat-
a joint return). The American Families Plan further ment. Gain of up to $250,000 for a single taxpayer
proposes to tax long-term capital gains as ordinary ($500,000 for a married couple filing a joint return)
income at a rate of 39.6% for higher-income earn- from the sale of a primary residence is excluded un-
ers, compared with the maximum long-term capital der Sec. 121, rather than deferred under Sec. 1031.

IN BRIEF watch for the many potential pitfalls ■ The current Sec. 1031 rules provide
that can derail an attempt to accomplish a great benefit to taxpayers and will
■ When real property that is held for a tax-deferred swap of properties. continue to do so to a lesser extent if
investment or for productive use in ■ As of this writing, Congress is the new limits proposed by the Biden
a trade or business is exchanged for considering tax reform proposals that administration are enacted. Thus, CPAs
other real property of “like kind,” Sec. may potentially limit the benefit from should educate their clients about
1031 of the Internal Revenue Code large Sec. 1031 exchanges. President how to best take advantage of the
allows the deferral of capital gains and Joe Biden’s administration has proposed opportunity to defer capital gain and
depreciation recapture. capping the amount of gain that can depreciation recapture on like-kind
■ Strict rules govern like-kind exchanges be deferred at $500,000 ($1 million for exchanges of real property.
of real property. Tax advisers should married individuals filing jointly).

To comment on this article or to suggest an idea for another article, contact Dave Strausfeld, a JofA senior editor, at
David.Strausfeld@aicpa-cima.com.

32 | Journal of Accountancy January 2022