Section 1031: What if it’s eliminated?

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Apparently the House Ways and Means Committee likes making the lives of real estate investors “fun.” On February 26, 2014, the Committee released a draft of a Comprehensive Tax Reform Proposal, which, if enacted, could repeal Section 1031, the like kind provision. The Senate Finance Committee has also proposed a repeal of the 1031 Exchange, “but leaves the door open for real property and intangible property exchanges. It also suggests a potential modification of the like-kind standard to the narrower section 1033 standard requiring that properties be similar in service or use,” as reported by the San Diego Source.

As you can imagine, the commercial real estate industry is less than thrilled with the likelihood of losing 1031, which allows folks to defer capital gains taxes. Removing it could really make quite a mess. But there is a way around the 1031 if this actually happens.

As reported by the New York Real Estate Journal, “Using IRC section 453, the installment sale provision, also nearly 100 years old, those seeking tax deferral on the sale of any highly appreciated property can do so through the use of a Deferred Sales Trust (DST).”

A Deferred Sales Trust is a capital gain tax-deferred strategy, which can provide tax-planning advantages. Sellers do not have to buy a replacement property, as with a 1031 Exchange. With this strategy, folks can sell property through a charitable trust, for example. The trust then receives the profits from the sale of the property. Taxes are paid when the seller receives proceeds from that trust.

If you read IRS Code Sec. 453, you’ll notice it never mentions Deferred Sales Trust. You will find reference to the Installment Sale Method, though. As always, though, it’s best to check with a certified accountant for more.

It’ll be interesting to see what happens. Hopefully, the 1031 will just be left alone, as is.