This is the first of a series of posts on Tax Reform. In this series, I will be covering: what Tax Reform means, the legislative process for enacting it, the likely timing of its arrival, the estate & gift tax and income tax proposals already presented by the Trump administration and the U.S. House of Representatives, and possible planning strategies that businesses and individuals may wish to consider.
What Tax Reform Is
As a starter, what exactly is “Tax Reform”? Is it something you will know if you see it? Are there objective standards as to what constitutes “Tax Reform”?
The late Senator Russell B. Long, a Democrat from Louisiana, served more than four decades in the U.S. Senate. He was Chairman of the U.S. Finance Committee from 1966 to 1981, and was very influential in shaping our tax laws during the ’60s, ’70s and ’80s. In fact, he was one of the major contributors to the Tax Reform Act of 1986.
As a footnote, the ’86 Act, enacted over thirty years ago, was the last major tax reform legislation passed by our lawmakers. So, it has been a long time since we have seen Tax Reform.
House Ways and Means Committee Chairman David Camp issued a discussion draft of the Tax Reform Act of 2014 earlier this year. The proposed legislation spans almost 1,000 pages.* One of its provisions repeals IRC § 1031 and taxpayers’ ability to participate in tax-deferred exchanges. The Obama Administration responded to Chairman Camp’s proposal. It wants to retain IRC § 1031, but limit its application to $1,000,000 of tax deferral per taxpayer in any tax year. Based upon the precise wording of the White House’s response to Chairman Camp’s proposal, it appears the $1,000,000 limitation would only apply to real property exchanges. So, personal property exchanges would be spared from the proposed limitation. Of course, there is always the possibility that lawmakers, if they take this approach, would expand the White House’s proposed limitation to apply to personal property exchanges. Only time will tell.
Despite this talk, many practitioners believe IRC § 1031 will survive tax reform unscathed. After reviewing a recent report issued by the Treasury Office of Tax Analysis (“OTA”), I am not convinced IRC § 1031 will remain unchanged in any tax reform legislation enacted by lawmakers.
In its report, Treasury points out that tax deferral under IRC § 1031 is not considered a tax expenditure for purposes of the federal budget. The Joint Committee on Taxation (“JCT”), however, does not adopt this approach. Rather, it considers the gain deferral from IRC § 1031 exchanges as a tax expenditure. For 2014, the JCT estimates IRC § 1031 will result in a federal tax expenditure of about $8.7 billion. That number is large enough to get the attention of lawmakers.
The OTA report primarily focuses on 2007. In that year, it found:
- Total IRC § 1031 tax deferral amounted to about $82.6 billion.
- $25.8 billion was claimed by C corporations.
- $35.6 billion was claimed by partnerships.
- $21.2 billion was claimed by individuals.
- Over one half of the tax deferral claimed by C corporations related to vehicle exchanges (e.g., car rental companies or businesses with large fleets of trucks and/or automobiles).
- Banks are a significant user of IRC § 1031 exchanges (primarily exchanges of automobile fleets).
- Real estate exchanges accounted for almost 90% of the exchanges conducted by partnerships.
- Nearly $10.6 billion of the gain deferred by individuals related to residential rental properties.
- Over 90% of all individual exchanges involved real estate.
- Tax deferral from real estate dramatically decreased from 2007 to 2010 due to the recession, but interestingly, during this same period, tax deferral by corporations increased by about $3.5 billion due to an increase in vehicle exchanges.
The OTA report makes one thing crystal clear--IRC § 1031 exchanges result in a significant amount of gain deferral. Accordingly, eliminating or limiting exchanges could be a significant source of tax revenue. Treasury is obviously closely analyzing IRC § 1031 for this very reason.
Tax practitioners that believe IRC § 1031 will remain unchanged, if and when we see tax reform, may be unrealistic. Given these huge numbers and the JCT’s view of exchanges (i.e., they result in a tax expenditure), it is not farfetched to conclude there is a high probability tax reform will result in the repeal of IRC § 1031 as Chairman Camp proposes or a significant limitation on the amount of tax deferral as the Obama Administration proposes. STAY TUNED!
*For a more detailed discussion of the proposed legislation, see: http://www.larrystaxlaw.com/2014/02/are-we-going-to-see-tax-reform-2014
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- “The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, But It Isn’t Free of Potholes and Obstacles,” Portland Tax ForumVirtual Event, 9.24.20
- “The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, But It Isn’t Free of Potholes and Obstacles,” Oregon Association of Tax ConsultantsBeaverton, OR, To be rescheduled
- To be rescheduled