New Rules Affect Property Swaps

QUESTION: I am planning to relocate to Northern California. If I sell my income property in Los Angeles and buy a single-family home in my new location and then rent out the new house, will I qualify for a so-called 1031 exchange for tax purposes? I wouldn’t live in the house for at least two years, and probably longer.--J. C.

ANSWER: If you want to qualify for a so-called like-kind exchange, don’t sell your income property without consulting your realtor or tax adviser. The rules were revised by the Tax Reform Act of 1984, and while they don’t go so far as to require you to transfer the ownership of your Southern California property to the same person from whom you buy the Northern California home, they are more strict than before.

It is to your advantage to qualify for an exchange rather than an outright sale and purchase because, in an exchange, you don’t have to recognize the taxable gain or loss at the time of transfer. Only when the property received in the exchange is sold or otherwise disposed of do you have to pay taxes on any gain.

In the past, such transfers of business or investment property have been recognized as exchanges for tax purposes even if the exchange of properties didn’t occur simultaneously. (Both the property traded and the property to be received must be held for business or investment purposes, so such things as a home or a family car don’t qualify for like-kind exchanges. In addition, the properties must be tangible properties, so stocks and bonds don’t qualify.) All a taxpayer had to do was give up his property in return for a promise that he would receive the same kind of property (hence, the term like-kind ) at some unspecified future date.

The 1984 tax law confirmed the validity of these so-called non-simultaneous like-kind exchanges. But it tightened the rules by setting some time limits, thus removing some of the attraction of non-simultaneous exchanges.

To qualify for an exchange now, you must identify the property to be exchanged within 45 days of the transfer of ownership in your income property. The exchange must be completed within 180 days of the original transfer or by the due date of the tax return for that year, whichever comes first.

In other words, if you transfer your Los Angeles property on March 1, you must identify the like-kind property to be received in exchange by April 15 and receive that property by Aug. 28. Since your return for this year won’t be due until April 15, 1986, at the earliest (assuming you are a calendar-year taxpayer), Aug. 28, 1985, rather than April 15, 1986, is the applicable exchange date.

The new rules apply to transfers made after July 18, 1984. Taxpayers who transferred property before then have until Jan. 1, 1987, to complete the exchange--except for taxpayers who identified their replacement property by June 13, 1984. They need not complete their exchanges until Dec. 31, 1988.

Q. A recent Los Angeles Times story on tax reform mentioned that a couple received $11,000 in Social Security benefits but that only $2,550 of those benefits were subject to taxation. How do you arrive at that figure?--M. W.

A. The formula is rather complicated. To figure what percentage of your Social Security benefits are taxable, you must know how much you received in wages, pensions, interest, dividends and other taxable income; whether you collected any tax-exempt interest (such as interest on municipal bonds) for the year; whether you are entitled to a married-couple deduction or deductions for foreign or U.S. possessions income; what your Social Security benefits amounted to, and whether you are single or married.

Begin with your adjusted gross income. To that amount, add any tax-exempt interest received. Then, add back in any of the following deductions or exclusions that you are allowed to subtract from your income for tax purposes: deduction for a married couple when both work, foreign earned-income exclusion, foreign housing exclusion or deduction and exclusion of income from U.S. possessions or Puerto Rico.

To the resulting amount, called modified adjusted gross income, add in half of your total Social Security benefits for the year.

From that figure, subtract $25,000 if you are single or are separated from your spouse and file a separate return. If you are married and file a joint return, subtract $32,000 from the modified income figure. If the resulting figure is zero or a negative amount, you may stop there. None of your benefits will be taxed. Otherwise, divide the result by two.

The amount of Social Security benefits on which you will be taxed is either the final number you calculated or one-half of your benefits, whichever is less.

In the example you cited, the couple’s adjusted gross income (as well as adjusted modified gross income) totaled $31,600, and their Social Security benefits totaled $11,000. Add half of the benefits ($5,500) to their adjusted gross income to get $37,100. They file a joint return, so subtract the base amount for taxpayers filing jointly ($32,000). The result is $5,100.

Half of that amount is $2,550. Since that figure is less than half of their Social Security benefits ($5,500), they are taxed on $2,550.

Until last year, Social Security benefits weren’t taxed at all. The decision to tax as much as half of a recipients’ benefits was made in order to raise tax revenues and on the theory that recipients had never been taxed on the half of their benefits contributed by their employer.

As with any change in the tax laws, there has been considerable confusion among Social Security recipients about whose benefits are taxed and whose aren’t. If you received benefits in 1984, you should have received from the IRS Form SSA-1090, Social Security Benefit Statement, and a notice that explains how to determine whether any of your benefits are taxable.

You may discover that the amount stated there doesn’t agree with your receipts. Don’t panic. Sometimes adjustments are made to your Social Security benefits before you receive them, and the IRS simply discounted those adjustments. That, too, will be explained in the literature that you receive from the IRS.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.