Certain Capital Gains Now Exempt from Louisiana Income Tax

Effective January 1, 2010, gains on the sale of privately held businesses or interests in such businesses will be exempt from individual income taxation in Louisiana.  Act No. 457 of the 2009 Louisiana regular legislative session excludes from an individual’s Louisiana tax table income any “[i]ncome from net capital gains, which shall be limited to gains recognized and treated for federal income tax purposes as arising from the sale or exchange of an equity interest in or substantially all the assets of a non-publicly traded corporation, partnership, limited liability company, or other business organization commercially domiciled in this state."  With the top Louisiana individual income tax rate at 6%, the ability to structure a sale to fit within this exemption may result in significant tax savings. 

Two particular scenarios come to mind that will likely affect the way certain Louisiana property transactions are structured in the future.   

Drop and Swaps

Often, when real property owned through a partnership is in the process of being sold, one or more of the partners may wish to defer the capital gains taxes on the sale by completing a 1031 exchange and acquiring like-kind replacement property, while others may want to “cash out.”  Since sales of partnership/equity interests don’t qualify for the tax-deferral benefits of Section 1031, one technique sometimes used to accomplish the goal of tax deferral is to liquidate the partnership and distribute (or “drop”) the asset(s) to the individual partners as tenants-in-common.  The former partners then transfer their respective undivided interests in the property to a buyer.  Those electing to pursue a 1031 exchange (i.e., a “swap”), arrange for the opening of an exchange through a Qualified Intermediary, such as First American Exchange Company, ahead of closing, and the others simply receive a check at closing. 

This technique obviously requires the cooperation of the non-exchange-electing partners.  The new tax change, however, gives the non-electing partners less incentive to cooperate, as doing so and dropping down to and selling a real property interest would likely increase their Louisiana tax liability. 

Also, since sales of the specified interests/assets are now subject only to Federal capital gains taxes, and are exempt from Louisiana taxation, taxpayers considering a “drop and swap” will have to weigh the increased transactional costs of a “drop and swap” against the now limited tax-deferral benefits of pursuing same. 

It should also be noted that “drop and swaps” are an area that the IRS is focused on, and there may be some risks associated with this technique.  The assistance of a tax and/or legal advisor is always recommended to assure that all parties’ interests are met with the least amount of risk. 

Single-Asset Entities

Finally, the new law seems to indicate that when a private, single-asset entity sells its one asset (i.e., “substantially all the assets”), the capital gains from that sale would be excluded from the entity’s state taxable income.  This may inspire the creation of separate entities for each asset owned by an investor or group of investors. 

As with any exchange or other transaction, you should consult with your accountant or tax advisor to be sure that your transaction is structured in the best way to meet your investment objectives.