• New Oregon Rule Allows Exchanges Into Out-of-State Replacement Property
  • May 2, 2003
  • Law Firm: Miller Nash LLP - Portland Office
  • Oregon appears to be on the verge of more completely conforming its tax-free exchange laws to federal income tax laws. For many years, Oregon has generally followed federal tax-free exchange laws. Oregon law did not conform to federal law, however, if the relinquished property in the exchange was located in Oregon but the replacement property was not. In that situation, the taxpayer had to pay Oregon tax. In 1991, Oregon passed legislation that allowed only Oregon individual residents to avoid gain on the sale of Oregon relinquished property for out-of-state replacement property.

    The 1991 amendments were recently declared unconstitutional by the Oregon Tax Court Magistrate Division case of Fisher v. Department of Revenue issued on February 12, 2001. As a result of Fisher, both houses of the Oregon legislature passed HB 2206 (A-Engrossed). Governor Kitzhaber is expected to sign the bill into law.

    HB 2206 now provides that Oregon will not tax the exchange of Oregon relinquished property in a tax-free exchange if the replacement property is not in Oregon. When the replacement property is ultimately sold, however, an Oregon tax will be due on the gain that would have been recognized on the sale of the original relinquished property. If the replacement property sells for less than it was purchased for, the gain will be reduced. The Oregon Department of Revenue is authorized to require taxpayers who defer gain in this manner to file an annual report with the Oregon Department of Revenue. This will allow the Oregon Department of Revenue to better track taxpayers who have invested in out-of-state property as part of a tax-free exchange.

    For CPAs and other tax technophiles who read this, the actual wording of the statute is a little more complicated. It actually provides that Oregon will tax the sale of the replacement property when it is sold. The gain will be the difference between the basis of the replacement property and the lesser of (i) the fair market value of the replacement property on the date on which the taxpayer acquired it and (ii) the fair market value of the replacement property on the date on which the replacement property is sold. If this difference produces a loss, the taxpayer can deduct the loss on his Oregon return.

    Here is an example of how the new law will work. Joe Taxpayer exchanges Oregon relinquished property in which he has a basis of $300,000 for $500,000. If he does not complete a tax-free exchange, his taxable gain will be $200,000. But Joe purchases Utah replacement property for $700,000. When the Utah replacement property is eventually sold, Joe must recognize the deferred gain of $200,000. If the Utah replacement property is sold for $650,000, then Joe needs to recognize only $150,000 of Oregon gain. The loss (reduction in value from $700,000 to $650,000) on the sale of the Utah replacement property reduces the gain that Joe must otherwise recognize.

    HB 2206 is effective 91 days after the legislature adjourns. For exchanges completed prior to the effective date of the Act, it is unclear how the Oregon Department of Revenue will treat exchanges of Oregon property for out-of-state replacement property.