by: Scott Jackson
This time last year I was writing about the Tangible Property Regulations and the impact it would have on business taxes but that was soooo last year. Hopefully businesses were able to avail themselves of those regulations and get a big fat refund. No such fun regulation (225 pages – thanks IRS, I did need help sleeping) was handed to us this year, but we can rely on some old favorites.
I have recently seen increased activity in gain deferral under IRC Section 1031, i.e. a 1031 exchange, and cost segregation studies. I am sure I lost half the people reading this when I put in a code section but stick with me because it is really useful. A 1031 exchange allows for the ability to sell assets, acquire new assets and, if structured properly, not pay tax on the sale. You read that right, no taxes (at least not right away)!
If you use assets in a trade or business or hold for investment there is an opportunity to replace those assets with like-kind property at no gain. There are rules that are very time specific and boring, so I suggest talking with your tax advisor who gets excited about those types of things. The categories of property that qualify as like-kind are broad, but are eligible for exchange as long as they are used in your business or held for investment.
Examples of eligible property:
- Most Real Estate (shopping centers, land, parking lots, apartments etc…)for other Real Estate
- Certain Oil, Gas and Mineral Rights
Some fun examples (Yes these are actually in the US Code):
- Livestock (but only of the same sex, don’t even get me started on transgender livestock)
- Fishing Licenses
- Major League Sports Contracts
There are downsides to not paying any taxes on the sale. The basis in the new asset is not what you paid; rather, it is the carryover basis from the property you sold. The gain is therefore “deferred” until the next sale of the property. The lower basis means less depreciation. Also, you must use all of the cash from the sale to acquire like-kind property. If you don’t use all of the cash, you will be taxed to the extent of cash received.
Cost segregations reduce the depreciable life of purchased property. Many times a taxpayer allocates 20% of the purchase price to land and 80% to building. While easier, businesses are losing the time value of money due to lesser depreciation deductions. Land cannot be depreciated and buildings are depreciated over 39 years.
Cost segregation studies review the purchased or constructed assets and allocate the cost based on the tax classifications of the assets. Many times this moves 39 year property to 5, 7 and 15 year property, resulting in accelerated depreciation deductions. That means lower taxes in the early years of holding the property.
These rules have been around for many, many, many years and are starting to see more popularity as values have increased over the last few years. If you are looking to sell assets, 1031 exchanges can defer the gain and buyers can use cost segregations to reduce taxes. Old friends are often the best friends.