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Non-recognized property transfers – 351(a) and 1031 exchanges

Most exchanges of property are taxable events. Sometimes the US Congress legislates federal tax code that encourages economic growth. For example, Internal Revenue Code (IRC) Section 351(a) encourages the formation of a corporation; the exchanges of business property for corporate ownership (shares) under some circumstances do not have recognized immediate taxable gains. Any taxable consequences of the transaction are deferred to a future time. The social intent of this code section encourages incorporation of businesses. In a similar way, Congress ruled that like-kind IRC Section 1031 exchanges defer immediate taxable gains on a sale of real estate investment property. You might consider using a “1031 exchange” to defer paying taxes on a highly appreciated farm or ranch by “exchanging” proceeds for some other “like-kind” real estate and thus, postponing capital gains tax. Both these IRC sections thus describe non-recognition transactions.

You need to answer three questions in a nonrecognition transactions; (1) what is the gain realized in the exchange, (2) what would the gain recognized, and finally, (3) what is the basis in property received.

 

1) Gain realized in property given up is:

Fair Market Value (FMV) of assets and cash received

and

Amount of debt assumed by “other” party

    Less any exchange (“selling”) expense

Less the adjusted basis of the property given up

 

2) Gain immediately recognized in the exchange is:

Total cash received (unlike property called Boot)

and

Net liability, if any, assumed by “other” party. Any assumed liability by the “other” party is considered “money” received

    Less any exchange (“selling”) expenses paid

 

3) Basis of property received is:

Adjusted basis of transferred property

and

Net liabilities, if any, assumed by taxpayer

Plus “selling expense” (considered boot paid)

Plus gain recognized (from Step 2)

Less any Boot (cash, unlike-property) received

 

There are two requirements for a IRC Section 351(a) treatment; namely, (1) the exchange involves only the receipt of stock for transferred property, and, (2) immediately following the exchange of property for corporate stock, you have “control” (at least 80%) of the corporation as defined in IRC Section 368(c). The adjusted basis in property transferred to the corporation will ordinarily have the same value as the amount preceding the non-recognized exchange. The key requirement in a Section 1031 exchange is that the property has a productive use either in trade, business, or investment. A taxpayer not only defers capital gains taxes on their on their original investment property, they transfer taxes to the replacement property. There are no limits on the number of exchanges that can be transacted and thus, no restrictions on how far into the future the tax liability can be deferred.

Finally, before applying these “tax-free” exchange techniques, carefully research special situations involving related parties, if say, there is a disposition of exchanged like-kind property within 2 years, and issues when the amount of boot or assumed debt/liability is in excess of the transferred property’s adjusted basis.

IRS tips for the 2013 summertime taxpayer

IRS tax formsTax season ends for most people when they file their tax return on or before April 15. They either pay income taxes they still owe or wait for a refund of their excess withholding. There are, however, a small group of people who still have unresolved issues. Some taxpayers need to setup payment plans or address written questions from the IRS. The government sends out letters requesting additional documentation that might clarify discrepancies in the information reported on a tax return. You, as a taxpayer, need a plan of action if you face a tax bill or receive one of those disturbing IRS letters.

It is best to pay any legitimate outstanding tax bills from the IRS as soon as possible. Seek professional assistance if you receive an IRS letter like, for example, a CP 2000 proposing tax changes. The IRS balances shown are sometimes misleading. There are many different kinds of IRS notices and letters described here.

Interest and penalty charges for late filing and/or late payment accumulate from the time of your filing deadline. Any calculated tax balance for most tax payers is due on the 15th day of the fourth month of the calendar year following the tax year. Consider borrowing money from a commercial lender to pay your tax bill rather than entering into an IRS installment plan.

If you pay by personal check, cashier’s check or money order payable to U.S. Treasury. Take an additional moment to confirm your social security number or other tax identification number is written in the memo section.  It is important, when mailing a payment, to indicate which tax year you want the IRS to apply your payment. For example, when you mail a check now in 2013 but are sending a balance due for Tax year 2012 write 2012 IRS 1040-V; if you are making payment based on a separate IRS letter like a CP2000, Proposed Changes for Tax year 2011, write 2011 IRS CP2000. If you are making estimated tax payments for the current tax year, write 2013 IRS 1040-ES. Do not staple the payment to any voucher or paper. Indicate how you wish your payment to be applied to minimize confusion and possible bookkeeping errors.

Different Payment Methods

You can make payments through a debit card, a credit card or, based on the size and nature of your payments, even through the Electronic Federal Tax Payment System(EFTPS) or over a telephone (800-555-4477). Review a variety of options here. If you mail a payment, make certain you secure a return receipt from the US Post Office. If you want to use a debit or credit card, reference this IRS listing of recognized processing companies here.

Pay within 120 days

If you can pay the full balance due within 120 days or less, consider a short-term agreement rather than an installment plan. Review the Online Payment Agreement website here.

Make monthly payments

If you want to establish a monthly payment plan and owe $50,000 or less, apply for and receive prompt notification of approval using the Online Payment Agreement. You will have options and fee reductions if you can provide a bank account for a recurring direct debit of funds. Use IRS Form 9465, Installment Agreement Request. If you owe more than $50,000, complete IRS Form 433F, Collection Information Statement. There are one-time fees for these installment plans ranging from $105 down to $43.

Consider an Offer In Compromise (OIC)

There are ways to resolve outstanding tax debt if you cannot make payments. Seek professional assistance if you need to seek alternatives to an installment agreement. Use the OIC Pre-Qualifier tool to determine eligibility and review other options to resolve your tax issues. The IRS Fresh Start is another initiative that applies to both individual and small businesses. This program may also offer alternatives ways to address impending tax liens and the payment of back taxes.

Consider increasing withholding allowances

Review your IRS Form W-4, Employee’s Withholding Allowance Certificate, your employer uses to calculate your net pay. The government also provides an IRS Withholding Calculator tool to assist in your current year tax planning.

 

You can find a discussion of the IRS Collection Process in IRS Publication 594 here. The IRS also provides other information sources including videos and podcasts. Find a list of resources in English, Spanish, and American Sign Language (ASL) in the IRS Summertime Tax Tip 2013-14, August 2, 2013.