Montana Viewpoint
Unexpected reaction to a new rule from the Montana Department of Revenue sheds light on a potentially unethical business practice surrounding 1031 exchanges.

January 9, 2006

A rancher from out Livingston way called me the other day to ask about a story he’d read in the Western Livestock Reporter warning that the Montana Department of Revenue (DOR) was going to tax profits on “outgoing 1031 exchanges” differently. It seems my name was in the story as chairing the legislative committee that oversees the Department of Revenue.

“Oh dear,” I thought, “They are really rolling out the scare tactics on this one.”

“No,” I told him, “The Department is only spelling out in their rules a procedure that they already follow under the tax laws. Those profits on 1031 exchanges are already taxed. An honest person has nothing to fear because nothing has changed.”

For those not schooled in the mysteries of tax law, a 1031 exchange (named after the section of U. S. law that deals with it) allows people who sell business or investment property to defer reporting their sale profit (or “deferred gain”) if they acquire a similar property no later than six months after the sale. Because they can defer reporting their gain, they also defer paying taxes on that gain. They report the profit — and pay the tax — when they finally cash in the investment. Ranch property is common in a 1031 exchange.

Montana, like most states follows the federal law, so you can defer your Montana taxes, too. The problem is that some people who live out of state don’t know or don’t care that they are liable for tax in Montana, and others move out of state to evade paying the tax.

An “outgoing exchange” is an exchange of Montana property for out-of-state property, and the issue here is reporting the amount of gain of the Montana property that they have now disposed of.

A couple of months ago the DOR proposed a new rule to clarify how they interpret the part of Montana tax law that defines “Montana Source Income.” Since a central concept of fair taxation is that earnings are taxed in the state where they are earned, the proposed rule spells out that deferred gains earned in Montana are considered Montana Source Income, and both in and out of state residents will be taxed on them.

It did not change the way the Department treated the deferred income, it just clarified their practice to those unsure about it.

While the DOR viewed the proposed rule as a simple housekeeping task in keeping with the law, the Montana Realtors Association, the Montana Society of Certified Accountants, and the Montana Taxpayers Association feel that the DOR is writing new law, and are going full bore after it. 

So what’s their beef?

When I asked the Montana Taxpayers’ attorney if he felt the rule would have any kind of impact on Montana taxpayers, he told me there would be no impact, that they would be treated as they are now.

OK, and will out of state taxpayers be treated differently?

Yes, they will have to pay a tax identical to the one Montanans pay, and that will discourage them from investing in Montana. How’s that again? Is the Montana Taxpayers Association protecting the ability of non-residents to escape a tax that Montanan residents have to pay? There is something wrong here.

When I asked for examples of how this would hurt Montana, as they claim, I got some of the most convoluted explanations I have ever heard, but basically it all boiled down to the fact that treating non-residents the same as residents will hurt investment in Montana.

Essentially I take this to mean that the practice of Californians with deep pockets buying up Montana ranch land in 1031 exchanges, pricing it out of reach of local ranchers, and putting up No Trespassing signs is good for Montana and we don’t want to discourage them by treating them like we treat Montanans. I disagree.

My suspicion here is that there are some folks who think they have found a semi-legal way to use tax evasion as a pitch to sell land in Montana, and that they think the new rule closes that semi-legal “loophole.” It doesn’t, there’s no loophole there in the first place, and the rule merely clarifies existing law.

To protect their own interests they are conducting a campaign to get regular Montanans, who have nothing to fear from the new rule, to oppose it. To do this, they are spreading baseless rumors.

We know some Montanans take up temporary residence in a non-income tax state like Wyoming just to avoid paying Montana taxes on a sale of property (and yes, that’s both illegal and unethical, and the rule addresses that); we just didn’t know there was a cottage industry built up around getting out-of-state business people to “invest” in Montana by cheating the people of Montana out of tax revenue.

It’s depressing to think that there are folks who want to take advantage of others for their own advancement, but on the bright side, I had a great jaw fest with the rancher from Livingston, and I’d like to meet him some day.

Jim Elliott
Phone: 406-444-1556
Mail: State Senate Helena, MT 59620