As many wealthy clients settle into their retirement years, they have been able to use Section 1031 of the Internal Revenue Code as a tax-planning measure when buying and selling real estate as an investment property. Section 1031 lets investors defer capital-gains tax on the sale of the property if they reinvest the proceeds from that sale in like-kind property.
Normally, sellers of real estate end up paying pay as much as 20 percent capital gains taxes on the profit achieved when selling an investment property. But Section 1031 allows those capital gains to be deferred — a huge benefit for people late in life, who may be selling off a business property and buying a rental property by a lake.
With multiple exchanges, gains and taxes can end up being deferred for decades. If the exchanges are kept up long enough, the gains can escape taxation entirely, if the property's basis is stepped up to its fair market value after the death of the owner.
This has been a heavily used tax and estate planning strategy over the years, but it's being threatened now by government officials. Many times, these proposals can be considered dead on arrival: President Obama's more ambitious budget offerings will never get past a Republican-controlled House and Senate.
But limiting Section 1031 has been floated by members of both parties. Republican Congressman Dave Camp, head of the House Ways and Means Committee, proposed outright repeal late last year, while Obama has favored limiting tax-deferral to $1 million per taxpayer in any tax year.
The congressional Joint Committee on Taxation projects that repealing Section 1031 would increase revenues by $40.9 billion over 10 years. So there's a huge incentive for repeal.
That means your clients had better heed the possibility that it won't be there for them — and consider taking advantage of it now. In a nutshell, Section 1031 allows taxpayers to defer capital gains tax on the sale of their investment property if they reinvest the proceeds from the sale in other investment property. Unlike with a primary residence, sellers of real estate are required to pay capital gains taxes on the profit achieved when they sell an investment property.
Like-kind property
With a 1031 exchange, those taxes can be deferred if another, like-kind property of equal or greater value is purchased with equal or greater debt and under certain time constraints.
