Before the final GOP tax bill was completed, many in the real estate industry were concerned over the fate of Section 1031 of the U.S. Tax Code, otherwise known as the “Like-Kind Exchange.” A Section 1031 Exchange “is a real estate transaction involving the sale of one property with the tax on the capital gain deferred because of the qualified purchase of another like-kind property in exchange.” While normally all sales of real estate are taxable, Section 1031 creates an exception where the parties to the transaction are not taxed or are taxed minimally, at the time of the exchange.
Under the former version of Section 1031, real property transactions were clearly outlined; however, some personal property exchanges could qualify as well, such as that of an expensive painting. An earlier version of the GOP tax bill preserved the Section 1031 Exchange but limited the transactions of “like-kind property” to exchanges of real property only. Overall, the earlier bill showed comparatively favorable treatment toward commercial investors by preserving the Section 1031 exception and, under the Senate Proposal, lowering the depreciation period for commercial property from thirty-nine years to twenty-five. Proponents of the bill argued that maintaining tax breaks on commercial real estate encourages more investment and job creation.
The “like-kind” exchange policy, however, is not as simple as it may appear when it comes to cryptocurrency like Bitcoin. The IRS classifies cryptocurrency as property rather than actual currency. Therefore, it has been unclear whether the exchange of all cryptocurrency is considered a “like-kind” exchange under the statute. For example, if a Bitcoin user trades his Bitcoin for another popular cryptocurrency like Ethereum is this considered a “like-kind” exchange and thus not subject to tax? The IRS could go either way. On the one hand, both are cryptocurrencies; however, there are fundamental differences between the two.
Typically, the IRS has ruled that unless the items are of “the same nature or character” the trade does not fall within the confines of Section 1031. For example in California Federal Life Ins. Co. v. Commissioner, the Ninth Circuit upheld the Tax court’s ruling that Swiss francs and the gold coins were not of “like-kind” because the gold coins were primarily held by collectors and the Swiss francs were currently circulating currency, thus, they did not qualify for “like-kind” exchanges. However, the IRS has also noted that when “[t]he differences between gold coins minted by one country and gold coins minted by another country, where such coins are not used as a circulating medium of exchange, are primarily of size, shape, and amount of gold content” Section 1031 “like-kind” property exchanges are valid.
The new tax bill eliminated these concerns by limiting Section 1031 to real property. Section 13303 of the tax bill amended Section 1031 (a)(1) by deleting the word “property” and replacing it with “real property,” making it clear that Section 1031 no longer applies to cryptocurrency. Before the change, some CPAs urged cryptocurrency investors to avoid leveraging Section 1031 because there was “no ‘substantial authority’ for its use, which would be required to avoid tax penalties.” If improperly reported as a Section 1031 exchange, investors would open themselves up to the possibility of hefty penalties. Those lucky investors who heeded their CPAs’ warnings before the beginning of the year can let out a sigh of relief. The new version of Section 1031, which limits its application to real property, will only apply to deals made after December 31, 2017.
Whitney is a Second-Year Law Student at Wake Forest University School of Law where she is a staff member on the Journal of Business and Intellectual Property Law. She is a graduate of the University of Virginia where she earned her B.A. in History and Government. Before returning to law school, Whitney enjoyed a career in New York working as an Account Executive in the advertising industry and plans to pursue Real Estate and Intellectual Property Law after graduation.