There have been numerous developments related to IRC Section 1031 during 2012. In addition, significant tax law changes are slated to take effect beginning in 2013, although there is great uncertainty as to which changes will be implemented and which may possibly be avoided. The paragraphs below outline significant legal developments concerning Section 1031 exchanges, with links to the text of the cited cases and rulings:
Recent Legal Developments
PLR 201216007 (related parties): The IRS approved a series of 1031 exchanges involving replacement properties owned by parties related to the original exchanging taxpayer. The IRS noted that each related party must hold the replacement property acquired in its portion of the exchange for at least two (2) years. It also approved some taxable boot that would be received by the related party seller, provided the boot received was no more than five percent (5%) of the related party’s realized gain. Note that this ruling is similar to PLR 201048025, except that in PLR 201048025 the IRS did not provide a specific percentage amount for boot received by the related party seller.
PLR 2012120012 (related parties): The IRS also approved a series of exchanges into replacement properties owned by related parties, as long as the related party held the property for at least two (2) years. This ruling also noted that each related party receives their own identification and exchange time deadlines. In this ruling the group of related parties were ultimately allowed up to 540 days to acquire replacement property.
PLR 201242003 (reverse exchange with multiple related parties selling): This ruling addresses a relatively creative situation involving two related parties that both intended to acquire the same replacement property in accordance with IRC §1031 and also Rev. Proc. 2000-37. In PLR 201242003, the IRS permitted tax deferral under §1031 even though the Exchange Accommodation Titleholder (EAT) entered into Qualified Exchange Accommodation Arrangements (QEAAs) with more than one entity, including entities related to the taxpayer, who both had a bona fide intent to utilize a reverse exchange format to defer capital gain taxes. PLR 20122003 notes that Rev. Proc. 2000-37 does not prohibit an EAT from functioning as an EAT to more than one taxpayer under multiple QEAAs for the same parked exchange property.
Reesink v. Commissioner; T.C. Memo 2012-118 (conversion of a rental into a personal residence): In this case, the Reesinks completed a 1031 exchange into a replacement property that they intended to hold for investment. Although the property was never rented and the Reesinks moved into the replacement property 8 months after acquiring the replacement property, the taxpayer managed to convince the Tax Court that they intended to hold the property as a rental at the time they originally purchased the property. The taxpayer’s counsel presented testimony from credible witnesses that the taxpayer planned to rent the replacement property when it was acquired.
ILM 201238027 (conflicts in classifications of real and personal property where state laws conflict): This memorandum provides that Federal income tax law controls in determining whether properties are of like-kind. State laws classifying property as real or personal are relevant, but do not control in determining whether property is like-kind for purposes of Section 1031. Under federal law, the questions will be resolved based on factors including the rights of the parties, nature of title, physical properties, duration of interests and other factors relating to the nature and character of the properties in question.
Tax Law Changes
Capital Gain Tax Rate Increases: On January 1, 2013, the maximum long-term capital gain tax rate increased to 20 percent (up from 15 percent) for single filers with incomes above $400,000, and for married couples filing jointly with incomes exceeding $450,000. The effective tax rate can be as high as 23.8 percent for high earners also subject to the new “net investment income” surtax.
Medicare Tax: Beginning on January 1, 2013, a new Medicare surtax of 3.8 percent, pursuant to IRC Section 1411, will be applied to individuals, trusts and estates (but won’t apply to C Corporations) on “net investment income” above a threshold amount. The modified adjusted gross income threshold amount is $200,000 for single filers and $250,000 for married filers, and this net investment income includes capital gains from the sale of investment property and passive rental activities (as well as other activities).
Estate Tax Increasing: Beginning on January 1, 2013, the new law permanently has a unified federal estate exemption of approximately $5.25 million and a 40 percent maximum tax rate (which is up from last year’s 35 percent rate).
Bonus Depreciation: A 50-percent bonus depreciation is available for certain new personal property, and qualified leasehold improvement property placed into service in 2012 has been extended for another year through the end of 2013.