Source: https://us-internationaltradeservices.com/property-investments-and-investing/%C2%A7103-exchanges-under-the-trump-tax-law/
Timestamp: 2019-04-22 13:20:14+00:00

Document:
Half-truth #2: State law determines what is real property.
Is §1245 Property real property?
In 2014, Senator Baucus and the Senate Finance Committee proposed repeal of §1031 real property exchanges, and by establishing a pooling cost recovery system for personal property there would be no need for personal property exchanges under §1031.
The Obama Administration proposed to limit gain deferral under §1031 to $1,000,000 and eliminate §1031 exchanges of art and other collectibles.
The NAR, NAREIT, FEA, Real Estate Round Table and many more groups commented and lobbied against the changes while the Congressional Joint Committee on Taxation estimated that the “Repeal Score” would be $41 Billion in additional tax revenue over 10 years.
Reviewing more than 1.6 million commercial real estate transactions between 1997 and 2014, the study’s authors found the widespread use of §1031 improves liquidity and increases investment in the real estate market. The findings also show that some perceptions about the provision were not accurate.
According to the study, the temporary tax deferral provided by like-kind exchanges contributes not only to an increase in real estate investment but also an increase in overall taxes paid to the Treasury. The study found that government figures for the cost of §1031 like-kind exchanges are likely largely overstated and the benefits of the provision are overlooked.
Supplemental findings in 2017 by Prof. David C. Ling, Prof. Milena Petrova, and Prof. David Barker found that repeal of §1031 like-kind exchanges would have a negative impact on real estate values and that the official revenue loss to the government attributed to §1031 exchange was overstated as the result of a variety of factors.
Use of like-kind exchanges is widespread. In 2017, before the change in the Tax Code, nearly 6% of all commercial real estate transactions were like-kind exchanges. In high-tax states like California, Oregon, Colorado and Arizona, like-kind exchanges made up between 10-18% of real estate transactions.
When Trump tax bill finally passed, and 2018 began, Like-kind Real Property Exchanges remained, however, popular tax deferred personal property exchanges such as those involving Artwork, Collectibles, Franchises, and Broadcast Rights had been eliminated.
§1031(h) – real property located in the U.S. is not like kind to real property outside of the U.S.
Non-Truth: Incidental personal property is disregarded.
Reg. Sec. 1.1031(k)-1(c)(5) The “15% rule” is an identification rule only.
Half-truth 1: All real property is of “like-kind” to all other real property.
Which state law? Property tax? Lien priority? Transfer tax? Sales tax? and whose interpretation of which state law?
Whether natural gas pipelines are deemed to be realty or personalty for state or federal tax law purposes does not override the basic nature and character of the property involved. Natural gas pipelines are generally treated as real property because they are inherently permanent structures that are affixed to real property and will ordinarily remain for an indefinite period of time.
A steam turbine that is attached as a fixture in a land improvement and natural gas pipeline that is constructed along a right of way on real property are not of like kind. A Steam turbine is treated as personalty, machinery used in the production of electricity, while the natural gas pipeline is treated as real property.
Identical assets are like-kind regardless of their classification under state law; however, with the recent elimination of personal property of any kind from §1031 treatment, it is critical to determine if such assets constitute “real property “.
Where state laws classify assets differently, federal law will uniformly determine the “real vs. personal” property classification. Thus, assets classified under state law as real property may not be like-kind to other real property regardless of comparable ownership rights.
Treasury Regulations §1.856-3 defines “real estate assets” and “interests in real property” for REIT taxation.
Code §48 determines property status for old ITC credit.
Code §168 sets forth cost recovery rules.
Code §263A provides uniform capitalization rules.
Code §1245 details depreciation recapture on disposal of business property.
§1031(a)(2)(D) regarding exchanges of partnership interests has been repealed. Partnership interests cannot be exchanged because they are intangibles, and thus ineligible for §1031 treatment.
The exception is §761(a) elections out of Subchapter K.
TIC interests, Delaware statutory trusts, and mineral royalty trusts appear to be unaffected.
Fractional interests in aircraft are excluded as personal property.
Drop and swap and swap and drop transactions should remain largely unchanged.
The technical termination rules of §708(b)(1)(B) have been repealed which should make is easier for buyout of a partner to be an element of a partnership exchange.
Changes made in the 2017 Tax Act increase the likelihood of depreciation recapture issues in an otherwise non-taxable §1031 exchange of real property.
Recaptured depreciation is treated as ordinary income and not capital gain.
§1245 recapture is more likely due to enhanced §179 expensing and 100% bonus depreciation.
§1250 recapture is more likely due to 100% bonus depreciation.
Cost segregation recharacterization of fixtures from personal to real property for depreciation purposes only (e.g. wall coverings, lighting, special wiring).
“Qualified real property” (QRP) can be expensed to $1M under §179(f).
Improvements made to non-residential real property AND made after the property is first placed in service can also be expensed.
1st category: (A) roofs; (B) heating, ventilation, and air-conditioning property; (C) fire protection and alarm systems; and (D) security systems.
2nd category: “Qualified Improvement Property (QIP): Interior improvement other than: (1) enlargement of building; (2) elevator or escalator; (3) structural framework. (defined in §168(e)(6)).
QRP expensing applies to interior improvements for office tenants, and retail and other commercial properties.
Bewareof possible §1245 recapture when properties with §179 expensing are exchanged.
Is the §1245 Property real property for the purposes of a §1031 exchange?
If so, is it like-kind to other real property?
If so, what is the effect of depreciation recapture in the exchange?
Certain special categories of §1245 real property, like QRP or §1245(a)(3) real property are eligible for §1031 exchanges subject to depreciation recapture in many cases.
Fixtures classified as personal property are sometimes considered real property under state law but personal property for §168 purposes.
In ILM 200648026 the IRS states property classified as “tangible personal property” for §168 purposes does not control classification of real or personal for other code sections such as §263A.
But in ILM 201238027, the IRS includes §48, §263A and §1245 in analysis of whether property is real or personal for federal tax purposes in like-kind real property determination.
Although there is no guidance yet from the IRS, §168 classification may not control in real property or like-kind determination because §168 is based on the broad personal property classification under §48 (ITC). §1031, by contrast, has historically had broad definition of real property and like-kind real property.
The taxpayer still must consider that the depreciation recapture rules override gain deferral under §1031.
Replacement property must have same amount of §1245 property as relinquished property or there will be §1245 recapture as ordinary income.
The replacement property can be any §1245 property to avoid recapture but it does not need to be same depreciation class. For example, a relinquished §179 roof can be exchanged for replacement §1245 property with a similar life if it is otherwise like kind real property.
§1250 property is defined as all depreciable real property that is not §1245 real property.
Replacement property under §1031 must have §1250 property at least equal to the excess of accelerated depreciation over straight line (S/L) depreciation.
Non S/L §1250 Assets such as land improvements including sidewalks and landscaping can be depreciated on a 15 year accelerated basis, or qualify for the 100% bonus depreciation which is being phased out phased out through 2027).
§108 adjustments to basis can be used to offset cancellation of indebtedness income.
There is a question whether interior improvements made to non-residential property as defined in §168(e)(6)) qualify as QIP.
QIP can still be expensed under §179, but the recapture provisions are more onerous. Bonus depreciation is not available if the taxpayer is an “electing real estate business” for interest deductibility, as the taxpayer must elect the ADS (Alternative Depreciation System).
§179 expensing is still available for an electing real estate business.
A new §199A deduction provides a deduction of up to 20% of “qualified business income” for non-corporate taxpayers, but is limited to (a) 50% of W-2 wages or (b) 25% of W-2 wages plus 2.5% of unadjusted basis of qualified property. Qualified property includes depreciable real property, but excludes land.
The new law is still unclear how to compute unadjusted basis in the case of property acquired in a like-kind exchange.
The new interest expense limitation under §163(j) limits deductibility of business interest expense to 30% of “EBITDA” and starting in 2022, the limit is 30% of “EBIT”.
Under the new tax law there is no grandfathering of pre-existing debt except for “real property trade or business” and “farming business” and an election must be made. There is also an exception for small businesses eligible to use the cash method.
Taxpayers subject to the limitation should note that it reduces the advantages of post-exchange refinancings.
Segregation of real estate assets into a qualifying business may make sense for both the interest expense limitation and for the §199A deduction but could limit the ability to coordinate exchanges.

References: §1245
 §1031
 §1031
 §1031
 §1031
 §1031
 §1031
 §1031
 §1031

§1031
 §1031
 §1
 §48
 §168
 §263
 §1245

§1031
 §1031
 §761
 §708
 §1031

§1245
 §179

§1250
 §179
 §168
 §1245
 §179
 §1245
 §1031
 §1245
 §1245
 §1031
 §168
 §168
 §263
 §48
 §263
 §1245
 §168
 §168
 §48
 §1031
 §1031
 §1245
 §1245
 §1245
 §179
 §1245

§1250
 §1245
 §1031
 §1250
 §1250

§108
 §168
 §179

§179
 §199
 §163
 §199