The new Tax Cuts and Jobs Act, which is effective for years beginning after December 31, 2017, substantially limits Section 1031 Like Kind Exchanges by restricting it’s application to “real” property. Under the new tax law, by eliminating any type of “personal” property from the tax deferral provisions pertaining to exchanges of any “non currency” personal property of similar nature (such as art, rental income property including furniture and fixtures, farm animals such as dairy cows, etc.), exchanges of property that is not deemed “real” property, or real estate, must be valued at the time of the exchange and reported as a capital gain (either short or long term depending on the holding period). Although the U.S. Treasury Department needs to interpret the new law and promulgate regulations and the IRS needs to determine how it is enforced, the complexities are going to be substantial.
One example may affect the “swapping” of rental real estate between landlords or restaurants that include both the land, building as well as other business property. Whereas previously, the holder of one residential or commercial rental income property could enter into a Section 1031 like kind exchange and by following all the rules carry forward the cost basis of the transferred property for the acquired property, paying capital gains tax when the acquired property is actually sold for cash without identifying any personal property (such as furniture and fixtures that are not permanently affixed to the real property), there is a strong possibility that now the transaction will need to be appraised and those properties that are not defined as “real” but rather “personal” may need to be valued and reported as a currently taxable transaction. Although this would be a boom for the appraisers, it is an accounting nightmare that the T.D. and I.R.S. will need to address.
Traders in crypto currencies such as Bitcoins and the many other digital currencies will be affected as well. Although the IRS previously ruled that “cyber currency” is not true currency but rather “other” property, which enabled anyone who traded once digital currency for another without converting it into recognized national currency to defer any gain recognition until the digital “coins” were actually “sold” for dollars, Euro, Yen, etc. at which time capital gain tax would be payable if there is a gain. Under the new law, every time there is an exchange say of Bitcoins for Litecoins or Ethereum or Ripple, etc., the transaction needs to be valued in U.S. dollars and reported to the IRS. Depending on the number of transactions, the accounting could be a nightmare as a typical day trader in digital currency could conceivably exchange twenty different digital currencies in less than an hour. Unlike securities that are accounted for in like kind currency (i.e. shares of Exxon corporate stock on the NYSE which would be in U.S. Dollars or Nissan Motor Co., LTD on the Tokyo exchange in YEN, a trader in digital currency would need to carefully monitor each transaction and spend hours calculating the value of each transaction instead of tracking the dollars invested against dollars withdrawn from their digital wallet (or account).
A WORD TO THE WEARY: Given the high speculative risk involved, this could also spell big trouble for anyone who loses big and never returns to the market to generate future capital gains as the capital loss limitation remains at $3,000 while there is no way to carry the losses back to offset gains in prior years. Thus one could end up accumulating gains by virtue of exchanging digital currency, but when it came time to convert to cash, the value resulted in a cash loss.
While on the subject of digital currency, a reminder that any other transactions whereby goods or services are exchanged for crypto currency is deemed a taxable transaction and has been since 2014 (IR-2014-36, March. 25, 2014). Thus if you receive digital currency from your employer in exchange for your services, not only is the compensation subject to income tax, but also is subject to social security tax and other labor related contributions (i.e. unemployment tax, etc.).