The so-called “Fiscal Cliff” has dominated recent headlines, and with good reason. Although Congress may act to soften the blow, substantial tax increases are expected in 2013. The good news is that individuals and business selling property may be able to mitigate those tax implications through a 1031 exchange.

Here’s how it works: Section 1031 of the Internal Revenue Code specifies that if an asset is “sold” and the proceeds of that sale are reinvested in a “like-kind” property, then no gain or loss is recognized, allowing for the deferment of federal — and possibly state — capital gains taxes.

For example, if an investor sells an appreciated property for $3 million, generally she would expect to pay a capital gains tax on the profit. Once state and federal taxes are added, an Idaho taxpayer may end up paying up to 50 percent on the gains, which could equal a large portion of the property’s value.

By following the requirements of a 1031 exchange on the $3 million property, the investor could potentially save hundreds of thousands of dollars. It is important to note that if the replacement property is ever sold rather than exchanged, the deferred gain — plus any gain realized since the purchase of the replacement property — is subject to tax.

Any property shown to have productive business use or business intent is eligible as long as the owner buys a replacement property within 180 days. A 1031 exchange can be used for a wide variety of property, including aircraft, radio equipment, oil and gas subsurface rights and rental homes. (Consult your tax adviser for personal property like-kind definitions.)

To receive tax-deferred treatment, an independent party must act as a qualified intermediary to hold your funds between the sale of your relinquished property and the purchase of your replacement property.

Customers typically pay a flat fee for the exchange service and keep all of the interest earned in their trust account, which requires written customer approval for access to the funds.

Why now?

Tax incentives — set to expire at the end of this year — have recently allowed for accelerated write-offs of equipment purchases. The sale of totally depreciated equipment could produce substantial taxable gains.

In addition, gains from property sold will increase your total income, potentially bumping you into a higher tax bracket. Unless changed, the new tax environment could produce an effective rate for Idahoans as high as 50 percent.

How? Generally, investors expect to pay the federal capital gains tax rate, which will increase to 20 percent. Depreciation recapture on improved properties would be charged at 25 percent (more for equipment). People in partnerships and limited-liability companies report that income on personal returns. Add to that Idaho state tax of 7.4 percent.

In addition, the federal health care law adds a Medicare tax surcharge. There are also implications with regard to the alternative minimum tax, whose unindexed exclusion levels are affecting more people. Income from sales of your assets could bump your income above the AMT exclusion.

Expiring tax cuts and Medicare surcharges will make our income tax structure more progressive. Before making property investment changes, consult your tax adviser on the after-tax impact.

Mike Anderson, president of Zions Bank’s Exchange Services, a qualified intermediary for 1031 exchanges. michael.anderson @zionsbank.com, (877) 596-1031