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24 April 2018

A ’Real’ Business Problem with the New Tax Code

A ’Real’ Business Problem with the New Tax Code

When something as complex and nuanced as the U.S. tax code gets tweaked, one minor change can cause an avalanche of unintended headaches. One such tweak—supposedly meant to thwart farmers, manufacturers, and other businesses from swapping assets like trucks and machinery tax-free—now seems to be inadvertently hurting businesses like professional sports teams.

In this case, the change is to the like-kind exchanges provision (Code Section 1031), which essentially is eliminated for all exchanges but real estate. How? As The New York Times points out, “by adding a single word to the newly written tax code — ‘real’ — the law now allows only real estate swaps to qualify for [tax-free] special treatment.”

Under the changed language, businesses can no longer swap non-real estate property like vehicles and equipment without the potential of having to pay income taxes. That likely was something lawmakers understood going in. Lawmakers probably also understood that the added word would now mean that those exchanging cryptocurrencies might also  be subjected to capital gains taxes as well. What it seems they didn’t see coming was the effect it would have on professional sports trades. Specifically, sports franchises now face capital gains taxes whenever they exchange or trade highly paid players.

The U.S. Chamber of Commerce points out another problem with the Section 1031 change that affects many more businesses. According to the organization, the new rule does not address how to treat affixed personal property used within a building.

“A commonly cited example is carpeting, which is technically defined as personal property under the Federal law (for depreciation purposes),” the U.S. Chamber’s Caroline L. Harris recently wrote to the IRS. “However, 1031 exchanges currently rely on State law definitions for personal and real property, and most State laws include affixed personal property, e.g. carpeting, in their definitions of “real property.” Before…treating personal property such as carpeting as real property in a 1031 did not conflict with Federal law because both personal and real property were eligible for like-kind exchanges. However, since personal property is now excluded from 1031 eligibility, there could be a perceived conflict. While taxpayers believe items within a building such a carpet, etc. still qualify as part of the real property as defined under State laws, clarity on this issue would be helpful.”

The U.S. Chamber went on to point out more than a dozen additional areas of the new tax code it claims has confused the business community. Among those areas are:

  • What is now considered qualified business income (QBI): What activities can be aggregated at the partner level for purposes of the wage and asset tests? Can mutual fund shareholders receiving REIT dividends receive the 20% small business deduction?
  • What is now considered an applicable recovery period for real property: Do residential real estate firms apply a 30-year alternative depreciation system (ADS) period to properties placed in service after 2017 and depreciate existing residential real estate over 40 years as opposed to the prior law’s general depreciation period of 27.5 years?
  • Changes to the section on limiting business interest: How does a partnership affect owners’ calculations? How does “business interest” now apply to certain excluded businesses?
  • Are abatements and refunds now considered a government contribution and therefore now taxed as income?
  • Specifically, how will withholding tax on foreign partners’ share of effectively connected income (concerning sales of interests in publicly traded partnerships) be feasibly implemented?

You can read the full request by the U.S. Chamber, including several other tax areas, here. Want to find out what tax code changes could affect your business specifically? Feel free to contact us.

Image Copyright:  munktcu / 123RF Stock Photo

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