Bill targets state capital gains interpretation

Monday, January 10, 2011

The New Hampshire Senate is holding a hearing Tuesday on a bill that would prevent audits of certain types of capital gains of limited liability companies.

The bill has nothing to do with the controversial expansion of the interest and dividends tax on LLC distributions, which was passed at the last minute of last year’s budget session and has caused a firestorm in recent weeks among members of the business community.

The bill to be heard Tuesday relates to the business profits tax that LLCs have been paying for years. What is new – and what this bill is trying to prevent – has been the Department of Revenue Administration’s decision to retroactively tax capital gains that have been exempt under Section 1031 of the Internal Revenue Service code.

Section 1031 is part of the IRS code governing the reinvestment of capital gains. Just as homeowners don’t have to pay the capital gains on a property they sell, as long as they buy another house in a certain amount of time, businesses can defer paying the tax in the same way.

However, businesses often have to buy and sell commercial property under different entities, either because the banks require it, or because they want to segregate liability by making sure that all their entities technically have different owners.

The IRS ruled that it would “disregard” the different names of the entity selling a property and the entity buying a property as long as the ownership of those entities is basically the same.

But the DRA says the IRS ruling doesn’t apply to how the state tax is imposed, because the federal government is trying to capture an individual’s income, whereas the state taxes entities.

Thus, when an investor buys a property as one entity and sells it as another, the money is reinvested according to the IRS, but not as far as the state of New Hampshire is concerned. Instead, it is a capital gain that should be reflected in the company’s profits for that year, regulators say.

Thus far, DRA audits have affected some 30 companies, but some of them have been stuck with tax bills amounting to hundreds of thousands of dollars. Such examples have been scaring off investment in commercial real estate in New Hampshire, the New Hampshire Association of Realtors has argued.

Senate Bill 483, which would require that the state follow the Section 1031 rules, is scheduled to be heard beginning at 11:30 a.m. by the Senate Ways and Means Committee in State House Room 100. – BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW

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