Source: http://www.levinesegev.com/blog/2010/01/section-1031-tax-deferred-exchanges-good-bad-proposed-remedy/
Timestamp: 2015-10-05 01:22:09
Document Index: 174515141

Matched Legal Cases: ['§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§10311', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031', '§1031']

1031 Tax-Deferred Exchanges, Proposed Remedy | Real Estate and Business Law Blog | Levine Segev LLC
Section 1031 Tax-Deferred Exchanges: The Good, The Bad, And The Proposed Remedy
By Dr. Mark Lee Levine
Although Code §1031 has existed for many decades, there have also been a number of interesting issues to construe and interpret in the application of tax-deferred exchanges under Code §1031. The focus of this Note is to look to some of these issues and, in particular, to examine the basic structure of Code §1031, the advantages and disadvantages to the Section, and to suggest approaches to modify Code §1031 to eliminate some complexity and other troublesome areas concerned with the current application of Code §1031. I. BENEFITS OF CODE §1031: DETAILS: Code §1031 allows for the deferral of Federal income tax (and potentially the deferral of state tax), assuming one meets the requirements under Code §10311. If the requirements of Code §1031 have been met by the taxpayer, the taxpayer generally enjoys the deferral of income, and therefore the deferral of taxable gain, not the exclusion of potential taxable income from the disposition of trade or business or investment property.
In 1921, members of Congress recognized that if there were more transactions and the elimination of the hesitancy of undertaking transactions because of tax liability, this would be better for the society. The approach from the inception of Code §1031 has been to facilitate such tax deferrals. Not only does Code §1031 support such position, but cases2, Revenue Rulings3, Revenue Procedures4, Regulations5 and other governmental guidance6 often support the position to allow flexibility within Code §1031 transactions.
Current studies7 show that the amount of tax deferral by the employment of Code §1031 is in the billions of dollars each year. It is clear that taxpayers have been utilizing Code §1031 on a large scale. The benefits are clearly evident to taxpayers. They have the opportunity to move from one or more properties to one or more properties and allow for deferral of the tax. There is not much confusion as to the issue of benefits to taxpayers using Code §1031. (Of course, even though tax deferral may be present, this does not mean that taxpayers should always utilize what they perceive as benefits under Code §1031. See below.)
Taxpayers may find that the transaction in question is complex, as noted below. Taxpayers may determine that the timing and other needs for the taxpayer to act are not compatible with the planning for an exchange. In such instance, taxpayers may choose to not undertake a transaction to dispose of their existing property; or, taxpayers may chose to undertake the transaction and pay the tax (as a “sale”), realizing that the tax deferral did not meet their needs under the given circumstances.
II. DISADVANTAGES OF CODE §1031: DETAILS:
The concern for a taxpayer utilizing Code §1031 is to comply in a way that produces the deferral of taxable income. If the taxpayer fails to comply, as noted, taxable gain could be generated. However, even if the taxpayer complies with Code §1031, there can be some risk to the taxpayer. Such risks may produce very adverse tax and other economic positions to the taxpayer, who was attempting to enjoy the benefits of tax deferral under Code §1031.
1. IMPROPER ACTIONS OF THIRD PARTIES: One example of such concern, which is examined later in this Note, is the circumstance where a taxpayer had planned to defer tax by having monies held by a third party that were received from the disposition of the taxpayer’s property. If those funds are not available to the taxpayer, because the third party acts improperly, enters bankruptcy, or otherwise places the funds in jeopardy, the taxpayer faces adverse economic and adverse tax results.
2. COMPLEXITY: The more commonplace concern for the taxpayer is not with the unusual situation of a problem with a third party, who is involved with facilitating the taxpayer’s exchange. Rather, the concern for many taxpayers is often the complexity that is involved in undertaking the tax-deferred exchange in some circumstances. (If such complexity is particularly bothersome to the taxpayer, the taxpayer may choose to pay current income taxes and not use the tax benefits of the exchange.)
Such complexity can result from many of the requirements that are placed on taxpayers when undertaking an exchange that is not simultaneous in nature. For example, if Mr. X transfers his X-1 property to Miss Y, and Miss Y transfers her Y-1 property to Mr. X, this is straightforward, with little complexity, assuming there are no mortgages, no “non-like-kind” property is involved, and no other unusual circumstances exist.
However, to the contrary, as to the above points, if there are complexities because Mr. X received not only like-kind Y-1 property from Miss Y, but also Mr. X received non-like-kind property, changes in debt owing by X on X-1 property, etc., this may necessitate additional guidance to Mr. X by Mr. X’s CPA, broker, attorney, title company or others who might be involved in various aspects of the exchange.
To avoid these complexities, taxpayers sometimes elect to simply ignore the existence of Code §1031, opting not to use the exchange vehicle. If Mr. X, the seller, would simply receive monies from the sale and pay tax at the time of the sale.
Whether members of Congress anticipated such complexity when allowing for the tax-deferred exchange remains to be discussed. However, there is little doubt that there can be great complexity in many exchanges8.
As mentioned, taxpayers must consider not only the position of postponing taxable income, but also the implications of the same. Because Code §1031 is a deferral section, allowing taxpayers to avoid the tax on a current basis, taxpayers must anticipate that the gain, which is currently postponed, may be generated on future transactions. (Taxpayers generally prefer to defer tax and have the use of money that would otherwise have been paid in taxes. Further, taxpayers may anticipate that no tax will ever be paid on the gain, if the taxpayer continues to hold the property until the death9 of the taxpayer.)
Although there are clear advantages to using the exchange approach and deferral, as indicated above, there are many areas of potential disadvantages or negative positions to taxpayers that employ Code §1031. The potential of gain being taxed in the future, at a higher rate, is a negative consideration for the taxpayer.
If the taxpayer anticipates “selling’ a property to complete the exchange, the taxpayer must acquire a property that is otherwise qualified and within Code §1031, as stated, above. Thus, taxpayers are not free to simply dispose of the property; they must anticipate that one of the requirements of the exchange is to acquire a replacement property. This is a factor that has negative implication to some taxpayers; therefore, it will encourage them to sell for cash and pay tax, if they do not wish to acquire replacement property. Or, the taxpayer might consider not selling or disposing of property in the first place.
Taxpayers should not engage in the exchange approach where the taxpayer has little taxable income. One advantage of deferring gain is because of the time value of money. Thus, if there is no tax to be paid, because there is little taxable income by the taxpayer, there would be little incentive to incur the additional requirements of Code §1031 to defer gain, when the gain is slight.
Even if the gain is substantial, taxpayers must anticipate that they should weigh whether Code §1031 should be utilized, if the amount of taxes is not large. That is, even if the taxpayer has a substantial amount of gain from the disposition of property, the taxpayer may have offsetting losses or credits which would reduce the amount of net tax charged to the taxpayer. In such instance, the taxpayer should anticipate whether the exchange, and requirements to complete the exchange, outweigh the alterna