March 8, 2018

Tax Reform Limits Exchanges to Defer Taxes

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Article Highlights:

Deferring Tax with Like-Kind Exchanges
Changes Made by Tax Reform
Impact on Trade-ins

Note: This is one of a series of articles explaining how the various tax changes made by the GOP’s Tax Cuts & Jobs Act (referred to as the “Act” in the article), passed late in December 2017, might affect you and your family in 2018 and future years, and offering strategies you might employ to reduce your tax liability under the new tax laws.

Whenever you sell business or investment property and have a gain, you generally have to pay tax on the gain at the time of sale. In the past, the tax code provided an exception and allowed you to postpone paying tax on the gain if you reinvested the proceeds into similar property as part of a qualifying like-kind exchange. These types of exchanges are commonly called Sec. 1031 exchanges (referring to the tax code section that allows them). These rules have applied to real estate, cars, farm animals and other business and investment items that are like-kind property.

However, under the Act, and beginning in 2018, Sec. 1031 exchanges will only be allowed for exchanges of real property that is not held primarily for sale. It is important to note that real property located in the U.S. and real property located outside of the U.S. are not like-kind property for the purposes of these rules. Thus, exchanges of personal property and intangible property will no longer qualify for tax-deferred treatment.

Transition Rule - The provision generally applies to exchanges completed after December 31, 2017. However, an exception is provided for any exchange if the taxpayer disposes of the property disposed in the exchange on or before December 31, 2017, or if the taxpayer receives the property in the exchange on or before this date.

An example of this law change’s impact is when a business property such as a vehicle or machinery is traded in for a replacement. In the past, it was a tax strategy to sell the old property if its disposition resulted in a deductible tax loss and trade it in toward the new property if the disposition would result in a gain, thereby deferring the gain into the future. The Act has taken away that option, and now even trade-ins will result in a taxable transaction, whether it is a gain or loss.

Another example is investors in virtual currency who trade one type of virtual currency for another. They will be required to report their trades as capital gains/losses and won’t be able to use the 1031 tax-deferral rules.

If you have questions about how this change will impact your business or investment transactions, please give the office a call.

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Tax Reform Limits Exchanges to Defer Taxes