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Section 1031 Advisor Newsletter
Saturday, October 20, 2007

ALERT!! PENDING LEGISLATIVE CHANGES FOR SECTION 1031 EXCHANGES

If the Slowdown in the Real Estate Markets and the Sub Prime Loan Meltdown was not enough Good News for property investors, Congress has four pending tax changes which directly impact Section 1031 Exchanges as well as other transactions.

1. Pending Legislative Change #1:  (IMPACT:  Buyers and Sellers of Farm Real Estate)  Contained within the Heartland, Habitat, Harvest and Horticulture Act of 2007,  the bill disallows Section 1031 treatment for certain unimproved real estate. Specifically, this bill targets real estate [farms] for which the owner is receiving Agriculture Program Payments or Commodity Credit Corporation loans, unless the undeveloped land is retired from Farm program payments. While this language was proposed to reduce the attractiveness of Farm Real Estate for developers, it appears to only punish existing Farmers who sell and acquire additional farmland through Section 1031 exchanges. This legislative change is contrary to the spirit and intent of Section 1031, which delays taxation of gains as long as the owner of the business property reinvests in same or similar property.
   
   
2. Pending Legislative Change #2:  (IMPACT:  Buyers and Sellers of Collectibles)          Senate Finance Committee is currently considering the elimination of Section 1031 treatment for the sale of collectibles.
   
   
   
   Collectibles include any work of art, rug or antique, metal (except certain coins), gem stamp, coin, alcoholic beverage (e.g., vintage wines), musical instrument, historical object (such such document or clothes), or other item of tangible personal property that the IRS determines, from time to time, is a collectible. Current tax law provides that individual retirement accounts, as well as qualified plans are not permitted to invest in "collectibles." This change is anticipated to raise 175 million in tax revenue to help pay for the one year extension of the AMT fix. This proposal comes at a time of rapidly rising price appreciation across the board for collectibles. It is cynically believed that individual investors will not be organized enough to voice their disapproval in such a way to block this proposal. This may significantly impact the principal role that the New York Auction Houses play in the international art market, vis a vie the London and Paris markets, due to the inability to trade these investments on a tax deferred basis. It is time to e-mail your Senators!!
   
   See Andrew C. Worthington & Helen Higgs, 2001. "Art as an Investment: Risk, Return and Comovements in Major Painting Markets," School of Economics and Finance Discussion Papers and Working Papers Series 093, School of Economics and Finance, Queensland University of Technology.
   
   
3. Pending Legislative Change #3:  (IMPACT:  Buyers and Sellers of Property) Readers of my August 2007 newsletter are familiar with the benefits of Section 121 combined with Section 1031. Section 121(a) provides that gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years [defined to mean 24 months or 730 days as well as 2 calendar years] or more. Congress is slated to curb this generous provision for sales after 2007 and allow more of the gains to be taxable. The exact amending language is not known at this time, but we will keep our readers tuned in.
   
   
4. Pending Legislative Change #4:  (IMPACT:  All Taxpayers)  Codification of the economic substance doctrine. It is thought that this provision will raise approximately $10 billion per year as a revenue offset and would apply to transactions entered into after the date of enactment. A description provided by the Joint Committee on Taxation (JCT), states that the Senate Finance Committee measure clarifies and enhances the application of the economic substance doctrine to provide a uniform definition of economic substance that does not alter the flexibility of the courts in other respects. According to the JCT description, the measure provides that after a court determines the economic substance doctrine applies to a transaction, that transaction has economic substance only if the taxpayer establishes that the transaction changes the taxpayer's economic position in a meaningful way (apart from federal income tax consequences) and the taxpayer has a substantial non-federal-tax purpose for entering into the transaction.
   
   

   What are the Viewpoints of high ranking tax officials on Pending Legislative Change #4?  Two of the government's highest-ranking tax officials sharply criticized a proposal moving forward in Congress to codify the economic substance doctrine on October 12, even as they acknowledged it has a significant chance of becoming law. The viewpoints of both IRS Chief Counsel Donald Korb and Assistant Treasury Secretary for Tax Policy Eric Solomon were reported by BNA’s weekly tax report on October 22, 2007. Both officials spoke separately at a conference on corporate restructurings sponsored by the Practising Law Institute, and they urged Congress to leave the existing doctrine alone. “Today, it is a judicial construct used by courts to decide for themselves whether a transaction has economic substance, a system,” Korb said, “that would be compromised by the pending legislation, currently embedded in a bill offering tax relief to farmers.”

   “I think our system works very well with a flexible judicial rule, rather than an inflexible statutory rule,” Korb said on a panel shared by former IRS chief counsel, B. John Williams, now with Skadden, Arps, Slate, Meagher & Flom LLP, Washington, D.C., and Richard Lipton, Baker & McKenzie, Chicago, former chairman of the American Bar Association Section of Taxation. Korb and both private-sector panelists said they believe there is little chance the $10 billion in revenue predicted by Congress will materialize, given the difficulties IRS would face in asserting the strict liability 30% penalty for participating in an abusive deal lacking economic substance. “It seems to me to wreak more havoc than benefit,” Williams said. Korb said the legislation would impose a heavy administrative burden on the IRS, over and above the policy concerns it raises on the doctrine itself. “I foresee the day, if this becomes the law, every time IRS wants to assert the penalty, it will require a technical advice memorandum,” Korb said, predicting the chief counsel could have to sign off each time, putting that office in the middle of the audit process. Lipton said he believes the issue on the Hill “is being driven by revenue and only revenue,” noting that the penalty stakes for taxpayers could make tax advice significantly more expensive because more analysis will need to be done. “From the perspective of a practitioner who does transactions in the field, this is really stupid,” Lipton said. “And it won't raise a penny of revenue.”   (From BNA’s Weekly Tax Report, 10/22/07)
   
   Note: There are no private letter rulings, revenue procedures or revenue rulings in the last 30 days dealing with Section 1031 Exchanges.

Contact SPE

Phone: 513-412-3481
Email: steve@spe1031.com
www.spe1031.com