The general public and professional practitioners do not know how close we came to losing 1031 exchanges in the last tax reform, even though tax-free exchange of property has been in the tax code since 1921. For several years we have been on the board, a past president and part of the government affairs committee of the Federation of Exchange Accommodators (FEA), the national association of 1031 exchange Qualified Intermediaries. During 2016 and 2017 FEA voluntarily spent many hours walking the halls of Congress lobbying to protect 1031 exchanges. We are humbled to have worked with a small team of truly dedicated professional Qualified Intermediaries from across the country along with genius lobbying direction to keep 1031 exchanges for real estate in the tax code. We cannot thank them enough!
As part of implementing tax reform, Congress gives Treasury the job to provide regulations interpreting the new law. A new component of the tax law, 199A, provides pass-through businesses the ability to deduct 20% of their qualified business income if they meet specific parameters. Depending on an income threshold, rental real estate owners will use a formula that involves the unadjusted basis immediately after acquisition (UBIA) of qualifying property to determine if they get the deduction. In August 2018 Treasury issued a proposed regulation that did not help real estate owners who do 1031 exchanges. The Federation of Exchange Accommodators (FEA – we are on the board) and other real estate industry groups aggressively weighed into Treasury to provide an alternative “step in the shoes” treatment for real estate owners who do 1031 exchanges.
The final Treasury regulations adopt the suggested “step in the shoes” treatment. The “step in the shoes” treatment takes the basis of the relinquished property at the time it was originally acquired. Additional investment in the replacement property at the time of the exchange increases the original relinquished property UBIA. The examples in the final regulation are clear and cover transactions where the price of the relinquished property and acquired property vary, and there is cash out and boot. The “step in the shoes” approach is workable and indeed a significant improvement over the proposed regulation.
In October 2018 Ed Horan submitted commentary (https://bit.ly/2RAYyYs) requesting Treasury clarify that rental property owners will qualify for the new 199A deduction. His comments were also picked up by TAX NOTES, a national tax news service.
With the final 199A regulations, Treasury also issued Notice 2019-17 (https://bit.ly/2R1nenN) which is a proposed revenue procedure that provides for a safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for purposes of the new section 199A. Treasury acknowledged the issue is the subject of uncertainty for some taxpayers. Glad they are listening to Ed Horan!
President’s 2017 budget limits more 1031 exchanges
The President’s 2017 budget proposes the capital gain deferred on 1031 exchanges of all property be limited to one million dollars, per taxpayer, per year, effective at the end of 2016. This change is a dramatic limitation of 1031 exchanges on all business assets. Last years budget proposal limited only real property.
Art and collectibles are again proposed to be eliminated from 1031 like-kind treatment.
The budget explanation: https://www.treasury.gov/resource-center/tax-policy/Documents/General-Explanations-FY2017.pdf
1031 Exchangers should anticipate settlement delays with some delays caused by the new TRID Closing Procedures.
A recent NAR survey of real estate agents found nearly one-third of all transactions encounter a delay of some sort. The majority of the delays were from financing issues. Some of the delay is from the new TRID Closing Disclosure (CD) procedures and documentation. Other reasons for delays are primarily appraisal values and home inspections.
1031 exchangers should be aware that there may be a delay in getting their relinquished property to settlement, and this could impact the closing on their new replacement property. With the uptick in housing sales and limited inventory there may be a delay in finding the replacement exchange property. While no fault of the 1031 exchanger, the system is causing delays that 1031 exchangers need to anticipate. 1031 exchanges have strict timelines and the law does not accommodate delays for transactions. It is important that exchangers not cut the 45 day identification and 180 day exchange completion dates too closely, but allow time for possible delays to both find, purchase and finance their replacement property.
Maryland has announced that as of January 1, 2016, the amount to be withheld at settlement from nonresident individual sellers and exchangers of real property is now 7.5% of the net proceeds. For nonresident entities the rate is 8.25%. The law has been in place since 2003 shocking many non-resident sellers who are unaware that MD will take a percentage of their proceeds at settlement time. The rate of withholding has been rising.
Maryland recognizes the federal 1031 exchange law and will grant an exemption if you meet certain criteria. If you need help with a 1031 exchange and are a MD nonresident we can help with the frustrating MD Certificate of Full or Partial Exemption submission process.
The MD nonresident withholding law requires that a new deed may not be recorded unless the tax is paid to the Clerk of the County Circuit Court. For nonresident entities the rate is 8.25%. No tax needs to be withheld if the nonresident seller or exchanger presents, at settlement, a Certificate of Full or Partial Exemption (Form MW506AE for 2016) issued by the Comptrollers Office. The Certificate will provide full exemption from withholding or provide the partial amount of tax to be withheld at settlement. To obtain an exemption certificate, nonresident exchangers must submit to the Comptroller of Maryland, twenty-one days in advance of settlement, Maryland Form MW506AE (Form MW506AE for 2016), Application for Certificate of Full or Partial Exemption. For 1031 exchangers the Comprtollers office also requires a cover letter from the qualified intermediary who has been hired to facilitate a 1031 exchange. The Comptroller’s Office will then issue the taxpayer their certificate. If a nonresident taxpayer has income from a Maryland property (even if there is a net loss), they need to file a Maryland Form 505, Maryland Nonresidential Income Tax Return, annually. If the Form 505 has not been filed for previous years, the Comptroller’s office may reject the application for exemption as there is no Maryland record that the property was held for business or rental purposes to qualify for the IRC Section 1031 exemption. The settlement agent is then required to collect the percentage from the net proceeds due to the exchanger/seller and submit that amount to the Clerk of the Court. Most likely this amount will not be refunded before the exchanger settles on a replacement property, and may become taxable federal income.
No tax will be collected if the seller certifies the property was their principal residence in accordance with the federal rules in IRC Section 121. If an individual or a corporation has paid withholding tax at settlement in excess of the amount owed, they may file an Application for Tentative Refund of Withholding on Sales of Real Property by Nonresidents (Maryland Form MW506NRS). The request for refund may be filed with the Comptroller after 60 days have elapsed from the date the tax was paid to the Clerk of the Court or Department of Assessments and Taxation by the settlement agent. For additional information, contact email@example.com or call 1-800-638-2937.
Here are links to the specific the MD non-resident withholding requirements.