Tax Reform Bill for Section 1031 Exchanges
The recently signed reform bill has changed IRS Code Section 1031 dealing with like-kind exchanges. Section 1031 is used by taxpayers to defer gain on the sale of property. Beginning in 2018, the bill limits the use of Section 1031 to only real property, land and buildings. With this bill taxpayers are no longer able to use the like-kind exchange for personal property such as vehicles, machinery and equipment. Those that proposed the elimination of like-kind exchanges for personal property stated that it is no longer needed because of the increased expensing provisions through Sec 179 and bonus depreciation. For the next five years, the bill allows 100% bonus depreciation on eligible personal property whether new or previously owned (used)… In addition, for the next five years, Section 179 will allow full expensing of up to $1,000,000 of eligible personal property.
The rules of a deferred exchange have not changed in that the exchange of real property has to take place with: 1) identifying replacement property(ies) within 45 days from the conclusion of the sale, and 2) completion of the transaction within 180 day from the conclusion of the sale. As has been the case all along, the monies must remain out of your control and be used to purchase the new property. Any relief of debt would be considered cash received unless on the replacement property there is new debt same as the old debt or in excess.
A couple examples would be:
A rancher trades in old equipment (fully depreciated) for new equipment. The old equipment is valued at $25,000 in the trade and the new equipment is worth $60,000.
The method used in 2017 would be to reduce the new equipment’s basis to $35,000 ($60,000-25,000) for the cash paid.
With the like-kind exchange option no longer available, the rancher will recognize $25,000 of ordinary income not subject to self-employment tax and would have the new equipment basis be $60,000, the full amount of which will be eligible for expensing either through bonus depreciation or Section 179. The expense of the new equipment would reduce income subject to self-employment taxes.
Timing of purchases would be important to make the expenses work out. If the rancher sells the old equipment in year 1, but does not purchase the new equipment until year 2, the rancher would recognize the income in year1 and the depreciation expense would be recognized in year 2.
Please contact our team at Ketel Thorstenson for further inquiries on the Section 1031 Exchange rules.