Madison Title Agency | Madison 1031 | LeaseProbe/Real Diligence | Madison SPECS

By Lee David Medinets, Esq., Chief Counsel, MCRES

The centerpiece of the “Tax Cuts and Jobs Act” (PL 115-97, December 22, 2017, 131 Stat 2054), as finally enacted, is to reduce the maximum corporate tax rate from 35% to 21%.  Much of what is in the new law complements that goal, such as the 20% reduction that pass-through business entities will now receive on most passive income (including real estate investments).  Most of the rest of the new law (including provisions aimed at closing loopholes) is directed at revenue enhancements designed to offset some of the revenue losses that the new tax reductions will produce.

§1031 and Real Property
For several years now, the IRC §1031 like-kind exchange industry and the entire real estate industry have been deeply concerned that tax-deferred IRC § 1031 like-kind exchanges might be eliminated entirely or severely hobbled in the course of tax reform in order to provide a revenue enhancement.  This concern was not based on idle speculation.  There were repeated warnings of this possibility by well-informed Congressmen and other policy makers.  In response to this warning, the Federation of Exchange Accommodators and the real estate industry as a whole were thoughtful and persistent and they acted in a well-targeted manner.  Over several years, Congress has been educated on the benefits of like-kind exchanges in maintaining reasonable liquidity in real estate markets, encouraging continuing investment in real estate, encouraging efficient use of real estate, preserving family farms, and so forth.  This collective effort has markedly increased the support in Congress for like-kind exchanges.

On the other hand, there was a strong movement in Congress to provide for 100% expensing, in some form or another, of all depreciable assets.  It was argued that even permanent structures on real estate, which generally have had a 27.5- or 39-year depreciable life (now, under the new law, increased to 30 or 40 years, respectively), should be subject to 100% expensing.  A provision for immediate expensing of office and apartment towers, shopping centers and the like would almost certainly have caused a construction bubble followed by a real estate crash.  Either through industry efforts or through its own research, Congress has come to the same conclusion.

The final version of the new tax law provides for vastly expanded bonus depreciation and expensing, but it does not come close to the immediate expensing of all real estate improvements that was originally proposed.  In fact, new construction and structural expansion of real estate improvements have been excluded from bonus depreciation, as they should be.  Interior renovations of commercial property (not residential property), on the other hand, qualify for bonus depreciation.

§1031 and Personal Property
Because of the bonus depreciation and expensing provisions of the new law, Congress has decided that personal property no longer needs to be subject to tax-deferred exchanges under IRC §1031.  However, §1031 has otherwise been left intact.  References to “property” under §1031 now refer to “real property.”  All references to personal property have been deleted.

Preservation of the real estate portion of §1031 is a victory and a relief for everyone involved in the real estate business, and for the moment, that preservation seems safe.  It is worth noting, however, some of the downsides of failing to preserve personal property exchanges.  Many important types of personal property are not subject to depreciation such as certificates of need for nursing homes and liquor licenses.  More importantly, the bonus depreciation provisions of the new law are scheduled to sunset in phases, but the ability to make a tax deferred exchange of those assets appears to have disappeared permanently.  Many high-ticket personal property items such as aircraft, watercraft, trucks and farm equipment will be harder to trade in once bonus depreciation has expired.

§121 and the Tax Cuts and Jobs Act
The House draft version of the Tax Cuts and Jobs Act proposed a major change to IRC §121, the statute that allows for a $250,000/$500,000 tax deduction on the sale of a principal residence.  That law allowed taxpayers to take this deduction if they had resided on the premises as their principal residence for not less than two of the prior five years, and the deduction could not be taken more often than once in two years.  The House draft raised these requirements.  The taxpayer would have to reside on the premises as a principal residence for five of the prior eight years, and could not claim the deduction more often than once in five years.  The version of the Tax Cuts and Jobs Act that was enacted did not include these proposed changes.

§708 and Tax Partnerships
One final note on the Tax Cuts and Jobs Act:  IRC §708 has long provided for the “technical termination” of a tax partnership when 50% or more of the interest in that partnership is sold or exchanged during any 12-month period.  This provision has been a regular source of difficulties in structuring certain IRC §1031 like-kind exchanges.  Those difficulties no longer exist.  Technical termination of tax partnerships has been excised from §708.  A tax partnership will continue to exist so long as it continues to do any business.  It is unclear at this time if there will be any significant negative aspects to this change, but the possibility exists.  The ability to sell a going partnership wholesale may provide fertile opportunities for structuring abusive tax shelters as well as for structuring schemes that may not reach the level of abuse, but that may be appropriate for tax policy to discourage.