Lynch signs 1031 exchange tax fix

About 30 investors, assessed by the state Department of Revenue Administration for owing a total of $5 million in back taxes on various investments, are off the hook, thanks to a bill signed into law July 8 by Gov. John Lynch.The bill retroactively allows investors to engage in real estate exchanges permitted by federal law without paying capital gains taxes.“I’m very, very pleased,” said George Foss III, a Littleton escrow agent who facilitates such exchanges. Foss was the main advocate – along with the New Hampshire Association of Realtors – for the bill. “To think to come from a town that represents only 3 percent of the population and to have an effect on policy in one of the largest legislative bodies in the world, that is absolutely amazing,” said Foss.Senate Bill 483 covers a subset of exchanges exempted by Section 1031 of the federal tax code governing the reinvestment of capital gains. Just as homeowners, who don’t have to pay capital gains on a property they sell as long as they buy another house in a certain amount of time, real estate investors can use the same method in deferring taxes on such gains.However, real estate investors often have to buy and sell property under different entities, since they sometimes must satisfy lenders that those entities are free from various liens and encumbrances or they want to limit personal liability or protect other business holdings.The IRS previously ruled that it would “disregard” the different names of an entity selling the property and the entity buying a property as long as the ownership of those entities are basically the same.

Defining ‘disregards’

But New Hampshire took a different stance because it doesn’t have a personal income tax, and its business profit tax is imposed on entities only. So when an investor buys a property under one entity and sells it under another, the money isn’t reinvested as far as the state is concerned. Instead, it is deemed a capital gain that should be reflected in the company’s profits for that year.Ironically, it was the federal interpretation clarifying why such “disregards” were permitted that caused the DRA to determine that they should be taxed under New Hampshire law.The problem, said Foss, is that the DRA’s new interpretation wasn’t backed by a specific law, or even a rule. It was done by audit, and investors, who were scrupulously following federal law, were told by the DRA that they owed hundreds of thousands of dollars in back taxes on transactions going back to 2005.

Several said that the tax interpretation could wipe them out.Aside from the fate of individual investors, Foss and the Realtors warned that outlawing such like-kind exchanges would scare investors away from the state, as it had in other states that changed their law to capture this income.While Foss couldn’t be happier about the bill, he did say that investors should still be careful when making such transactions. For one, state law is silent on whether exchanges in which an investor sells a property as an LLC and buys it as an individual is free from the state capital gains tax, even though an investor can do so under federal law.And even under federal law, such exchanges have to go through an escrow agent, to make sure that funds aren’t commingled with any other.

Bob Sanders can be reached at