Guest blog by Dave Brown, President, CES® - IPE 1031

The Section 1031 like-kind exchange is a powerful tool used by business owners, investors and others to transition real property assets into new assets that may more appropriately meet their needs. When exchanges occur near year-end, the following exchange-related issues and planning matters should be kept in mind:

Current and New Capital Gains Rates

As we approach 2025 and the coming years, changes may be in store for both federal and state tax rates. As a result, advantages may exist choosing a certain year to schedule closings if there may be a cash-out event due to either a failed exchange or a partial deferred exchange with some cash boot. As an example, the state of Iowa capital gains tax rates will be reduced from 5.7% to 3.8% on January 1, 2025, making it advantageous to schedule closings with cash boot in 2025. (See “Installment Sale Treatment” heading below.) Further, while federal capital gains tax rates will not be impacted by the expiration of the Tax Cuts and Jobs Act (TCJA) at the end of 2025, with 2025 dubbed by members of Congress as “the Superbowl of tax,” it will be important for taxpayers and their advisors to follow negotiations and plan accordingly.

Installment Sale Treatment for Failed or Partial Exchanges

Under the installment sale reporting rules, proceeds received by a taxpayer for an exchange that begins in one year, but fails in the subsequent year, can be reported as received in either year at the taxpayer’s discretion. This applies equally to a partially deferred exchange when the taxpayer receives unused exchange proceeds or cash boot at the conclusion of the exchange period with a failed exchange. With proper planning, taxpayers can utilize the installment sale election rules to report gain in the year after the start of an exchange transaction.

Depreciation Recapture in Section 1031 Exchanges

For certain improved assets, some components of real property can be reclassified as depreciable for tax purposes under I.R.C. Section 1245 rules relating to depreciation of personal property. To avoid Section 1245 recapture with a Section 1031 exchange, it is necessary to acquire new Section 1245 qualifying replacement property of a sufficient amount.

Under the TCJA, personal property exchanges were eliminated but replaced by bonus depreciation provisions temporarily permitting 100% full expensing of certain short-lived assets acquired by a taxpayer. With full expensing having expired, for 2024, expensing is permitted at 60%, declining to 40% in 2025, 20% in 2026, and eliminated entirely thereafter. As a result of these reducing levels of permitted expensing, it is possible that recapture may be owed if sufficient Section 1245 qualifying replacement property has not been purchased. Further, to offset recapture occurring in a certain tax year, it is important to acquire sufficient depreciable property in the same tax year.

Tax Filing Extensions

An exchanger must close on its replacement property within the earlier of 180 days following the transfer of the relinquished property, or the due date for the exchanger’s federal income tax return for the year of the relinquished property transfer. For exchanges beginning after October 17, an extension for filing the return must be requested if a taxpayer needs to utilize the entire 180-day exchange period to acquire replacement property.

IPE 1031 as a Resource to Exchangers and Advisors

As a leading independent qualified intermediary for Section 1031 exchanges, we regularly field questions from and consult with attorneys, accountants, lenders, trustees, realtors, auctioneers and other real estate professionals on various exchange-related issues and scenarios. In all cases, we welcome the opportunity to act as a resource for exchangers and their advisors.

Disclaimer: Peoples Company partners with Dave Brown and IPE 1031. The information provided in this blog is for informational purposes only and should not be considered tax, legal, or investment advice. Readers should consult their professional advisors regarding their specific circumstances.