Tax Reform and its Possible Impact on Section 1031
Keeping Property Exchanges Out Of The Crosshairs
Article by Max Hansen
September 5, 2017
Uncertainty about several proposed tax reform ideas in Congress concerns farmers, ranchers, and land owners in general, writes Max Hansen. Influential legislators have suggested that lower rates and immediate expensing for business assets would negate the need for Section 1031 like-kind exchanges, writes Hansen in a Land Investor article. Like-kind exchanges are used extensively in agricultural and commercial real estate. The quandry for property owners is that these proposals do not effectively cover the benefits of like-kind exchanges. The absence of these benefits would reduce the value of their investment in land. Hansen argues that the elimination of like-kind exchanges for property does not support the primary purpose of tax reform: to stimulate economic growth.
For farmers, ranchers, non-depreciable land can make up 80 to 100 percent of the value of an investment, Hansen explains. For commercial property owners, the value can be 30 to 50 percent. Even with the House Republican Blueprint promise of lower tax rates, the value of the investments and life savings wrapped up in property is diminished by the tax bill, he says. Hansen argues that the absence of like-kind exchanges for land, and the resulting tax liability, would cause a “lock-in effect,” where land owners would reconsider selling, or worse, not sell at all.
“Deferring the gain recognition in an exchange removes the lock-in effect, takes the government out of the decision-making process, and permits taxpayers to engage in opportunistic transactions that make good business and investment sense, without the fear of negative tax ramifications,” he writes.
Hansen’s article appeared in the September 5, 2017 issue of Land Investor. Max Hansen is President and CEO of American Equity Exchange, Inc., an attorney and Certified Exchange Specialist®. He is a government affairs committee co-chair at the Federation of Exchange Accommodators.
Re-published with permission from www.1031taxreform.com
1031 Is Fair And Valuable In The Economy: John Harrison Op-Ed In The Hill
In a country looking to expand economic activity and generate growth, Section 1031 like-kind exchanges provide a helpful, fair, and valuable benefit to the private economy, writes John Harrison, director and CEO of ADISA. His op-ed, titled “$8 billion reasons to save key tax deferment from reform ax,” appeared in The Hill on August 18, 2017. Harrison writes that 1031 exchanges create construction activity and jobs in the real estate and other industries, benefiting the government and national economy.
Repeal of Section 1031 may bring immediate funds to the government, but would damage the national economy in the long-run, Harrison points out. He writes that repeal of like-kind exchanges would discourage business investment, cause longer holding periods for real estate, a decline of real estate prices, and a significant increase in rental prices–as much as 38 percent in highly-taxed markets. He cites the 2015 EY study on the potential repeal of Section 1031, “Economic Impact of Repealing Like Kind Exchange Rules,” and the 2015 study by Professors David C. Ling and Milena Petrova, “The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate.”
ADISA, or the Alternative Direct Investment and Securities Association, is the nation’s largest trade association representing the non-traded alternative investment space.
“Section 1031 is a fair and thoughtful means to maintain private sector investments, which results in significant economic stimiulus,” writes Harrison. With well-crafted tax reform, he writes, “we must not throw the baby out with the bathwater.”
Re-published with permission from www.1031taxreform.com
Sam Zell To Maria Bartiromo: 1031 Creates Incentive To Sell
Sam Zell discussed with Fox Business host Maria Bartiromo the importance of retaining 1031 exchanges for its impact on the commercial real estate industry. He mentioned that legislators could be considering changing the rule during a discussion of the potential impact of tax reform on the economy.
Zell, the chairman and founder of Equity Group Investments founder and a well-known figure in the commercial real estate industry made the point that 1031 exchanges are a major rule that incentivizes taxpayers to sell. Section 1031 exchanges affect a large portion of commercial real estate decisions, he said. Without 1031 exchanges, Zell said, “I’d never sell” low-basis properties.
Re-published with permission from www.1031taxreform.com
Letter To The Editor: Equipment Manufacturers, Dealers Depend On 1031 Exchanges
“Manufacturers of equipment that builds our infrastructure, like bulldozers and excavators; the dealers who sell them; and the builders who put them to use all rely” on Section 1031 like-kind exchanges, writes Carrie Roider in a letter to editor published in the St. Louis Post-Dispatch. Roider is the CEO of Erb Equipment, a heavy equipment supplier with locations in Illinois, Indiana, Kentucky, Missouri.
In her July 11, 2017 letter, Roider calls Section 1031 a critical provision that stimulates the economy. “Economists consider the like-kind exchange a smart lever for growth. Congress should too,” she writes. She warns that cutting 1031 exchanges would negatively affect many industries, including farmers and small manufacturers. Section 1031 is fair and essential, she writes, for small business owners to manage capital, fund upgrades, and grow their businesses.
Re-published with permission from www.1031taxreform.com
Bloomberg BNA Explores Farmer Concerns On Like-Kind Exchange Repeal
Tax Reform That Kills Like-Kind Swaps a Red Flag for Farmers
Article by Allyson Versprille
June 1, 2017
Bloomberg BNA reporter Allyson Versprille covers the effect on farmers and conservation easements should House Republicans replace like-kind exchanges with immediate expensing as part of a broader tax reform effort. The June 1, 2017 article, “Tax Reform That Kills Like Kind Swaps a Red Flag for Farmers,” offers multiple perspectives on the preservation of Section 1031.
Full Article Credit:
Reproduced with permission from Daily Tax Report, 104 DTR G-3 (June 1, 2017). Copyright 2017 by The Bureau of National Affairs, Inc. (800-372-1033) <http://www.bna.com>
Tax Notes: Advocates Aim To Preserve Like-Kind Exchange In Tax Reform
In a May 8, 2017 Tax Notes article, “Advocates Aim to Preserve Like-Kind Exchange in Tax Reform,” writer Emily L. Foster explores issues surrounding repeal of Section 1031 like-kind exchanges, the historical context, and the effects of current tax reform initiatives on the provision. Experts discuss the potential of a repeal in the face of a reemergence of ideas from former House Ways and Means Committee Chair Dave Camp’s Tax Reform Act of 2014, as a revenue raiser for other proposals, and its relationship with 100 percent expensing for business assets and current tax reform proposals.
Article reposted with permission from Tax Analysts. Original publication: Tax Notes by Tax Analysts. “Advocates Aim to Preserve Like-Kind Exchange in Tax Reform,” by Emily L. Foster. May 8, 2017, pp. 726-730.
Nevada Letter To The Editor: Keep Commercial Real Estate Tax Incentive
Elko Daily Free Press
Letter written by Kim Washington
April 20, 2017
Re-published with permission from www.1031taxreform.com
There’s an old saying, “If it ain’t broke, why fix it?” This adage is especially true when it comes to a well-functioning tax code, such as Section 1031, also known as “like kind” exchanges. Like kind exchanges are a tried-and-true part of our nation’s tax code which strengthens our economy and encourages reinvestment in Nevada’s businesses. Section 1031 works as a forceful investment tool for Nevada’s commercial real estate market, creating opportunity for economic growth…
Read the entire letter at the Elko Daily Free Press
Section 1031 Like-Kind Exchanges: Current Threats To A Hundred Year Tax Tool
January 14, 2017 By Suzanne Goldstein Baker, Federation of Exchange Accomodators (FEA) Director
REALTORS® Land Institute Terra Firma Magazine
This article is republished with permission from the REALTORS® Land Insitute's Terra Firma magazine, Winter 2017, pp 44-47.
Readers are encouraged to read the full publication at www.rliland.com/about-us/terra-firma-magazine.
Almost one hundred years ago, Congress enacted Internal Revenue Code Section 1031, permitting deferral of capital gains and recapture tax on like-kind exchanges. Two primary purposes of the tax law were: 1) to avoid unfair taxation of ongoing investments in property and 2) to encourage active reinvestment. These purposes are even more relevant today in our global economy than they were in 1921. Section 1031 not only permits efficient use of capital to preserve and manage cash flow, it also encourages U.S. businesses to reinvest in their domestic operations, rather than offshoring business activity.
Impact of the Presidential Election
Fast forward ninety-five years to the 2016 Presidential election. In a surprise finish to a long and sordid year of election drama, Donald J. Trump was elected President and Republicans retained majorities in both the House and the Senate. This trifecta of power centers ratchets up the threat to Section 1031.
Impact of Tax Reform Options on Owner-Occupied Housing
The National Association of REALTORS® (NAR) engaged consulting firm PricewaterhouseCoopers to review the impacts of an illustrative comprehensive tax reform option that would: lower and consolidate marginal tax rates to three rates with a top rate of 33 percent; double the standard deduction; eliminate all itemized deductions, other than charitable contributions and mortgage interest; eliminate the Alternative Minimum Tax; and cap the tax rate on pass-through business income at 25 percent. Read “NAR Issue Brief: Summary of NAR Study on Tax Reform” here. Download the full report here. Some the highlights are below:
- Homeowners with an adjusted gross income (AGI) between $50,000 and $200,000 would see an average annual tax increase of $815. Non-homeowners with AGI in the same range would see an average annual tax reduction of $516.
- Home prices nationwide in the short run would fall by 10.2 percent as a result of the comprehensive tax reform option.
- The combined tax savings for those who claim the mortgage interest deduction (MID) and real estate tax deduction would fall from over $1.3 trillion for fiscal years 2018-2027 under the current law to just $232 billion under the comprehensive tax reform option, a drop of 82 percent.
- An estimated 83 percent of all personal income taxes are paid by homeowners.
- Non-homeowners, across all income categories, would see tax decreases on average.
Source: National Association of REALTORS®; 6/1/2017
Top 10 Reasons to Preserve Section 1031
- Section 1031 Like-Kind Exchanges (LKEs) encourage investment and reinvestment in U.S. assets, and makes it easier for taxpayers to relocate or upgrade into assets that better meet their business needs.
- §1031 was enacted in 1921 for two primary purposes: 1) to avoid unfair taxation of ongoing investments in property and 2) to encourage active reinvestment.
- §1031 has survived numerous tax reform efforts for almost 100 years because 1) it is based on sound tax policy that prevents taxation of cash flow when there is “continuity of investment” and no cashing out, and 2) it stimulates the economy through transactional activity.
- LKEs have a substantial economic stimulus effects on a myriad of industries, including real estate, contractors, title insurers, lenders, equipment dealers/manufacturers, transportation, energy and agriculture.
MYTH or FACT: There are many misconceptions on 1031 exchanges and we want to make sure you know the facts.
1031 exchanges directly benefit millions of American businesses and investors every year. Section 1031 encourages businesses to expand domestically and grow the U.S. economy. Industry studies show that Section 1031 is vitally important to creating new transactional activity domestically, encouraging small businesses to expand, fostering job creation and contributing to economic growth nationwide. Investors and businesses in many industries, including residential and commercial real estate, transportation, equipment/vehicle rental/leasing, and construction rely on 1031 exchanges to grow their businesses.
MYTH: I do not own real estate so a repeal of section 1031 will not affect me.
FACT: Everyday, American consumers benefit from 1031 exchanges. Here are just a few examples:
- Purchasing Products or Services: Americans pay less for products and services because businesses can use 1031 exchanges to replace equipment rather than using capital which helps keep costs lower. The products are then delivered by a company that probably exchanges its delivery fleets keeping their costs down (and keeps the fleets turned over regularly ensuring the vehicles on the road are better maintained). Farmers regularly use section 1031 to acquire better farmland and replace farm equipment and livestock.
- Renting a Place to Live: Exchangers make up a large percentage of owners of single family home rentals and multi-family rental properties. The ability to exchange allows the exchanger to reinvest all net proceeds into the replacement property which requires less financing. This helps keep the cost of ownership down and allows the property owners to rent for less.
- Using Public Transportation: Most public transportation fleets (buses, trains and taxis) are regularly exchanged for replacement vehicles, keeping the cost of ownership down so that the cost for users stays down.
- Traveling this Holiday Season: Airlines often use 1031 exchange to update their fleet and rental cars are the most frequently exchanged assets. Again, the ability to exchange helps keep costs down for consumers.
With the certainty of tax reform moving forward in Congress and 1031 exchanges at serious risk of being eliminated to help pay for lower tax rates, we are asking you to contact your Congressional Representatives and support Section 1031. The loss of Section 1031 will result in a significant loss of transactional activity and negatively affect investors, small businesses, real estate agents/brokers, title companies, lenders and many other ancillary services in the real estate industry, transportation, equipment/vehicle rental & leasing, and construction industries.
Click here to download a sample letter that you can customize, print and send to your representative.
Options for Reforming America's Tax Code click here to download the PDF
Op-Ed: Small Businesses Need Smart Tax Policies
November 29, 2016
By Lucas Eckland-Baker, Federation of Exchange Accomodators (FEA) Communications Coordinator
Reprinted with permission from the Houston Chronicle
November 25, 2016
Op-Ed by Randy Lee
Small businesses are the backbone of the American economy because they account for 99.7 percent of all U.S. employers. As Black Friday has become a shopping bonanza, a new concept, “Small Business Saturday,” encourages consumers to buy items from their local shopkeepers.
Small businesses thrive and consumers have many choices because smart tax policy encourages small business growth. In our current system, when a small business manages to make ends meet, they can reinvest profits into expansion and upgrades like new machinery, technology or additional assets. Proposals are floating around D.C. that would divert those would-be investments right to the IRS. “Small Business Saturday” is a good time to focus on tax policies that make success possible for the vast majority of our nation’s employers.
Small businesses depend on America’s free flow of capital in two ways. One, small business needs eager consumers. The like-kind exchange encourages reinvestment in assets produced by American small and medium sized businesses and manufacturers. Second, and most important, like-kind exchanges allow these small businesses to upgrade assets and grow without being punished by taxes. Like-kind exchanges remove artificial and unnecessary tax concerns from their calculus to invest in and grow their businesses. In fact, like-kind exchanges encourage entrepreneurs to grow their business and not “cash out.”
By Lucas Eckland-Baker, Federation of Exchange Accommodators (FEA) Communications Coordinator
In Letter to Senate Finance Committee, 1031 Coalition Says Recognition of Gain on Like-Kind Exchanges Would Hamper Business Competitiveness, Job Creation
In a May 10, 2016 letter, members of the Section 1031 Like-Kind Exchange Coalition urged Senate Finance Committee leaders to retain like-kind exchanges in the effort to create jobs, grow the economy, and raise wages. Like-kind exchanges are “integral to the efficient operation and ongoing vitality” of thousands of American businesses that contribute to the U.S. economy and job creation. Signers explain that like-kind exchanges promote uniformly agreed upon tax reform goals such as economic growth, job creation and increased competitiveness.
A strong economic rationale exists for the retention of section 1031 like-kind exchanges. A study by researchers at the University of Florida and Syracuse University supports that without like-kind exchanges, businesses and entrepreneurs would have less incentive and ability to make real estate and capital investments. These adverse effects on the U.S. economy would likely not be offset by lower tax rates.
By Lucas Eckland-Baker, Federation of Exchange Accommodators (FEA) Communications Coordinator
Nineteen Congressmen and Congresswomen, including several House Agriculture Committee members, sent a letter on June 1st, 2016 to Ways and Means Chair Kevin Brady expressing support for like-kind exchanges used in agriculture.
Like-kind exchanges are “overwhelmingly utilized by the agriculture industry, land owners, and operators” for flexibility and increased economic efficiencies, reads the letter. Legislators reminded the Chairman that farmers and landowners use section 1031 to acquire higher-grade land and equipment, geographically consolidate their operations, and preserve environmentally-sensitive lands. Retiring farmers preserve their life-savings when they move their investment away from farming.
By Lucas Eckland-Baker, Federation of Exchange Accommodators (FEA) Communications Coordinator
Turnover of Assets is Key to Economic Activity, says LKE Coalition Letter to House Ways
The Like-Kind Exchange Coalition has submitted a letter to House Ways and Means Chief Tax Counsel Ms. Barbara Angus encouraging the retention of like-kind exchanges at the current unlimited amount of gain deferral. Like-kind exchanges are similar to other non-recognition and tax deferral provisions because they result in no change to the economic position of the taxpayer. Taxpayers immediately recognize gain to the extent that cash or “boot” is received during an exchange.
“Like-kind exchanges are integral to the efficient operation and ongoing vitality of thousands of American businesses, which in turn strengthen the U.S. economy and create jobs,” reads the letter. A wide range of industries, business structures and sizes rely on like-kind exchanges, and as the Ling-Petrova microeconomic study findings show, entrepreneurs would have less incentive and ability to make real estate and other capital investments without the provision.
Lastly, the letter points out that a $1 million limitation of gain on deferral per year, as proposed by the Obama Administration, would be particularly harmful to the economic stream generated by like-kind exchanges of commercial real estate, agricultural land, and vehicle/equipment leasing. The turnover of assets is key to all of the economic activity and taxable revenue for ancillary businesses that depend on high-volume exchanges.
On October 4, 2016, Sen. Bernie Sanders announced Tuesday he would introduce legislation in the next session of Congress to fix our tax system and close loopholes Donald Trump used to possibly avoid paying federal income taxes for nearly two decades.
Following is the explanation of 1031 exchanges in his fact sheet:
“Usually capital gains on property are taxed when the property is sold, but taxpayers can swap pieces of property of the same type and claim that they have no gain to report to the IRS because there was technically no sale. The exchanges are often a sham because they often involve vastly different properties.”
For a fact sheet on the tax loopholes Sanders’ bill would close click here.
A limitation of Section 1031 like-kind exchanges was included among revisions to Secretary Hillary Clinton's tax platform on Thursday, September 22, 2016. The policy changes are aimed at reforming capital taxation, according to her campaign website. The proposed limitation on Section 1031 is believed to be similar to the Administration's FY2017 budget proposal. President Obama's FY2017 proposal would limit capital gains deferral to $1 million per taxpayer per year for both real and personal property and exclude art and collectibles from eligibility. According to the Center for a Responsible Federal Budget, the inclusion of this similar limitation would be expected to raise more than $35 billion dollars that would go towards funding Secretary Clinton's proposals.
Both campaigns' tax plans continue to evolve. However, the Trump campaign has not yet released many details of his tax proposals, and there is some ambiguity in what has been made public thus far.
Like-Kind Exchange Letters Sent to Clinton, Trump Campaigns
FEA Is Signer Among Real Estate and Land Conservation Associations
The Federation of Exchange Accomodators (FEA) was among 26 groups that signed letters sent to the Hillary Clinton and Donald Trump presidential campaigns explaining the benefit of real estate exchanges for small businesses, farmers, ranchers, and for use in land conservation. The timing of these letters is important, as both campaigns are developing and revising tax plans. The FEA is the national trade association for 1031 exchange practitioners and 1031 CORP. has been a member since 1995.
President's FY 2017 Budget includes Cap on 1031 Deferral
The President has once again proposed limiting the tax-deferral benefits afforded under sections.
Under section 1031 of the Internal Revenue Code, no gain or loss is recognized when business or investment property is exchanged for "like-kind" business or investment property. The Administration proposes to limit the amount of capital gain deferred under section 1031 to $1 million (indexed for inflation) per taxpayer per taxable year. In addition, art and collectibles would no longer be eligible for like-kind exchanges. The proposal would be effective for like-kind real and personal property exchanges completed after December 31, 2016.
Ling and Petrova Economic Study Released: "The Economic Impact of Repealing or Limiting Section 1031 Exchanges in Real Estate"
On Thursday, July 9, 2015, the Real Estate Like-Kind Exchange Coalition, of which the Federation of Exchange Accommodators (FEA) is a member, released new findings from a microeconomic study detailing the condition of like-kind exchanges and the impact a repeal of Section 1031 would have on the real estate industry in the Unites States.
The study, "The Economic Impact of Repealing or Limiting Section 1031 Exchanges in Real Estate," reviewed more than 1.6 million commercial real estate transaction between 1997 and 2014, and found widespread use of Section 1031, shows that like-kind exchanges improve and increase investment, and that common misperceptions about the provision are false. Read the overview and download the new study at www.1031taxreform.com/ling-petrova/
The study confirms findings from the Ernst & Young macroeconomic study released in March 2015. Together, the studies show the impact that a repeal of Section 1031 would have on the economy:
- real estate values would drop;
- the cost of capital would increase;
- average holding periods would increase;
- the velocity of investment in the economy will decrease;
- rents will rise; and
- the economy will contract.
In addition to these conclusions, the study found that 88% of replacement properties acquired through an exchange were eventually sold through a conventional, taxable sale, rather than exchanged again. As a result, taxes owed and paid to the government increased by an average 19% when compared to sales of non-exchanged replacement property acquired subsequent to a conventional sale. The study shows that the popular misconception that taxpayers engage in repeated exchanges, delaying taxes indefinitely, and sometimes completely until death, is false.
The findings of both studies further the argument that like-kind exchanges matter: they provide an essential incentive to improve properties, produce an increase in investment, reduce leverage and reduce holding periods. Like-kind exchanges help the economy keep moving. A repeal of the provision would unfairly burden several important industries, would harm the economy as a whole, and cost the government in the long run.
National Association of REALTORS® Nationwide Survey: Exchanges are "Fundamental to the Real Estate Investment Sector
Also released in July, 2015, a National Association of REALTORS® nationwide survey concluded that like-kind exchanges are "fundamental to the real estate investment sector." The report, "Like-Kind Exchanges: Real Estate Market Perspectives 2015," found that 63% of the REALTORS® respondents had participated in a like-kind exchanges between 2011 and 2014. A large percentage of these REALTORS® felt that many transactions would not have occurred had like-kind exchanges not been available. Almost 96% of survey respondents felt that real estate property values would decline as the result of a repeal. The report found that like-kind exchanges provide an important vehicle for real estate market participants to dispose and acquire property.
Sen. Bernie Sanders Plan to Restore Retirement Security to 10 Million Retirees uses Section 1031 as “Pay For”
On June 18, 2015, Sen. Bernie Sanders (I-Vt.) and presidential hopeful said he’s working to win passage of a bill that reverses a proposal passed last year that could result in deep pension cuts for retirees and workers in multi-employer pension plans. Sanders said his plan will protect the pensions of up to 10 million Americans.
The bill proposes to pay for a shortfall in the Pension Benefit Guaranty Corp that insures multi-employer pension plans by, among other things, limiting gain deferral from real estate exchanges to $1 million per taxpayer per year, and by eliminating 1031 treatment for collectibles and artwork.
For a copy of the legislation, click HERE.
Economic Study Finds Repeal of §1031 Would Hurt Small Businesses, Reduce GDP
The Section 1031 Like-Kind Exchange Coalition ("Coalition"), of which FEA is a member, released a study, "Economic Impact of Repealing Like-Kind Exchange Rules," on Tuesday morning, concluding that repealing the I.R.C. Section 1031 like-kind exchange rules would slow economic growth, reduce GDP and hurt many U.S. small businesses.
Ernst & Young was commissioned to conduct the study in response to legislative proposals to repeal Section 1031, and concludes that the reduction in GDP would be driven primarily by decreased business investment due to increased cost of capital.
Read an overview and download the study at www.1031taxreform.com/1031economics
The study confirmed that repeal of Section 1031 would negatively impact businesses and taxpayers, and that the negative effects would affect all taxpayers through a smaller economy. Findings show that the impact would be concentrated in industries that are heavily dependent on the use of §1031 like-kind exchanges, including real estate, vehicle and equipment leasing and rental, truck transportation, and construction.
On March 17, 2015, the Coalition hosted a press briefing featuring small business owners and industry professionals who described how like-kind exchanges helped their businesses and explained how repeal of Section 1031 would hurt their industries.
The findings of the Ernst & Young study quantify that a repeal of the like-kind exchange provisions to pay for a corporate rate cut, corporate tax reductions, or to fund increased spending, would unequivocally result in lower economic growth in the U.S. economy.
These findings demonstrate that a repeal of Section 1031 would be contrary to the stated goals of tax reform, namely: economic growth, revenue neutrality and fairness.
The study was authored by the Ernst & Young Quantitative Economics and Statistics team led by Robert J. Carroll, PhD, its National Director. Dr. Carroll previously served as Deputy Assistant Secretary for Tax Analysis of the US Treasury Department where he was the Department's top economist working on tax policy issues. He is also a former Senior Economist with the President's Council on Economic Advisers.
The Section 1031 Like-Kind Exchange Coalition is comprised of 12 diverse industry associations whose members represent more than one million U.S. businesses and taxpayers that will be severely impacted should Section 1031 be repealed.
Coalition Members include:
- Federation of Exchange Accommodators
- The Real Estate Roundtable
- National Association of REALTORS®
- National Association of Real Estate Investment Trusts
- National Multifamily Housing Council
- International Council of Shopping Centers
- American Rental Association
- American Car Rental Association
- Iowa Soybean Association
- Equipment Leasing and Finance Association
- Alternative and Direct Investment Securities Association
- Associated Equipment Distributors
President’s 2015 and 2016 Budget includes Cap on 1031 Deferral
Within the recently released President's 2015 budget is a proposal to limit gain deferral for real estate to $1 million per taxpayer per year (excerpt below).
This is another attack on IRC Section 1031. The justification for this proposal belies lack of understanding of the true benefits of §1031 exchanges.
Treasury Department "Green Book" Modifies the Like-Kind Exchange Rules for Real Property limiting the deferral to $1Million per taxpayer per year.-- "Pro small business rational."
When capital assets are sold or exchanged, capital gain or loss is generally recognized. Under section 1031, however, no gain or loss is recognized when business or investment property is exchanged for "like-kind" business or investment property. As a result, the tax on capital gain is deferred until a later realization event, provided that certain requirements are met. The "like-kind" standard under Section 1031, which focuses on the legal character of the property, allows for deferral of tax on the exchange of improved and unimproved real estate. Certain properties, including stocks, bonds, notes or other securities or evidences of indebtedness are excluded from non-recognition treatment under section 1031.
Reasons for Change
There is little justification for allowing deferral of the capital gain on the exchange of real property. The difficulty in valuing exchanged property is a primary historical justification for 1031 deferral. However, this rationale has limited appeal. For the exchange of one property for another of equal value to occur, taxpayers must be able to value the properties. In addition, many, if not most, exchanges affected by this proposal are facilitated by qualified intermediaries who help satisfy the exchange requirement by selling the exchanged property and acquiring the replacement property. These complex three party exchanges were not contemplated when the provision was enacted. They highlight the fact that valuation of exchanged property is not the hurdle it was when the provision was originally enacted. Further, the ability to exchange unimproved real estate for improved real estate encourages "permanent deferral" by allowing taxpayers to continue the cycle of tax deferred exchanges.
The proposal would limit the amount of capital gain deferred under Section 1031 from the exchange of real property to $1,000,000 (indexed for inflation) per taxpayer per taxable year. The proposal limits the amount of real estate gain that qualifies for deferral while preserving the ability of small businesses to generally continue current practices and maintain their investment in capital. Treasury would be granted regulatory authority necessary to implement the provision, including rules for aggregating multiple properties exchanged by related parties. The provision would be effective for like-kind exchanges completed after December 31, 2014.
Keep in mind that there has been NO bill introduced that would impact Section 1031. 1031 CORP. will keep you advised if any bill is introduced. In the meantime, contact your Congressional leaders to let them know you think section 1031 is good for you and good for the economy.
House Ways & Means Committee Chairman Camp's Proposes Repeal of Section 1031
On February 26, 2014, House Ways & Means Committee Chairman Dave Camp released a Discussion Draft of his Comprehensive Tax Reform Proposal. View the Full Tax Reform Plan. The Discussion Draft proposes repeal of IRC Section 1031 in its entirety. The language from the Discussion Draft appears below.
Sec. 3133. Repeal of like-kind exchanges
Current law: Under current law, an exchange of property, like a sale, generally is a taxable transaction. A special rule provides that no gain or loss is recognized to the extent that property held for productive use in the taxpayer's trade or business, or property held for investment purposes, is exchanged for property of a like-kind that also is held for productive use in a trade or business or for investment. The taxpayer receives a basis in the new property equal to the taxpayer's adjusted basis in the exchanged property. The like-kind exchange rule applies to a wide range of property from real estate to tangible personal property. It does not apply, however, to exchanges of stock in trade or other property held primarily for sale, stocks, bonds, partnership interests, certificates of trust or beneficial interest, other securities or evidences of indebtedness or interest, or to certain exchanges involving livestock or involving foreign property. A like-kind exchange does not require that the properties be exchanged simultaneously - as long as the property to be received in the exchange is identified within 45 days and ultimately received within 180 days of the sale of the originally property, gain is deferred.
Provision: Under the provision, the special rule allowing deferral of gain on like-kind exchanges would be repealed. The provision would be effective for transfers after 2014. However, a like-kind exchange would be permitted if a written binding contract is entered into on or before December 31, 2014, and the exchange under the contract is completed before January 1, 2017.
Considerations: The like-kind exchange rules currently allow taxpayers to defer tax on the built-in gains in property by exchanging it for similar property. With multiple exchanges, gains essentially may be deferred for decades, and ultimately escape taxation entirely if the property's basis is stepped up to its fair market value upon the death of the owner.
The current rules have no precise definition of "like-kind," which often leads to controversy with the IRS and provides significant opportunities for abuse.
JCT estimate: According to the Joint Committee on Taxation (JCT), the provision would increase revenues by $40.9 billion over 2014-2023.
The FEA has been preparing for this over the past few years, educating legislators about the powerful economic value of §1031. We have also spent the past year educating and building strong coalitions among the real estate, farming, equipment leasing, manufacturing and other industry groups that represent our clients.
1031 CORP. will continue to keep you informed through future newsletters and special announcements. The time will definitely come when we will ask you to contact your federal legislators to tell them how you have benefited from Section 1031.
Senate Finance Committee Releases Chairman's Staff Discussion Draft and Proposes Repeal of Section 1031
Today, Senate Finance Chairman Max Baucus released his third Staff Discussion Draft, this one focused on Cost Recovery and Accounting.
The Discussion Draft proposes elimination of IRC Section 1031 in its entirety along with sweeping changes to depreciation rules.
Neither the FEA nor our trusted advisors at Williams & Jensen, David Franasiak, Christopher Hatcher and Tess Illos, were surprised by this suggestion.
With a goal of reducing the corporate tax rate to 25%, we have been expecting the tax-writing committees to take a scythe to the tax code.
Remember that the tax writers have to begin somewhere, and that is what drafts for discussion are all about.
Since 2012, there has been increasing "noise" about IRC Section 1031 in Washington, DC and it has been identified as a potential revenue raiser for tax reform. Following are just a few of the potential threats identified recently by our national trade association, Federation of Exchange Accommodators (FEA):
- Congressman Dave Camp, Chair of the Committee on Ways and Means of the U.S. House of Representatives, formed a bipartisan tax reform working group charged with the task of fact finding and information gathering about present law. Group members will be examining eleven subjects, one of which being real estate tax matters. Over the next several months, the members will engage in a process of soliciting stakeholder input for their group(s). Section 1031 of the Internal Revenue Code is on the table as a potential revenue raiser for tax reform. The FEA and its members have submitted comments to a number of the working groups.
- The Joint Committee on Taxation (JCT) recently released its estimates of federal tax expenditures for fiscal years 2012-2017. The report contains 5 year estimated costs for various categories as outlays in the federal budget. In this report, totals for each tax expenditure are presented for two 5 year periods covering fiscal years 2012-2016 and fiscal years 2013-2017. As always, the report estimates the expenditure for Section 1031. This year's report says the deferral of gain on like-kind exchanges will cost $42 billion over a 5 year period (2012-2016) which is much higher than previous estimates. The impact of this revised estimate is that Section 1031 like-kind exchanges are a significantly larger target as a potential revenue raiser for tax reform.
- The Center on Budget and Policy Priorities think tank released a report entitled "Tax Expenditure Reform: Essential Ingredient of Needed Deficit Reduction." The report may be found by clicking here. The report states "Policymakers also should close various tax breaks that allow wealthy people to pay much lower or no taxes on certain forms of income." In the context of Section 1031, the report states: "The like-kind exchange provision is a strong candidate for reforms to reign in its excesses or repeal it." The FEA Response to CBBP rebutted the report addressing its inaccuracies.
- In April, 2013, the Senate Finance Committee (SFC) released a Policy Options White Paper on Business Investment and Innovation that included options to repeal section 1031. This is a very serious development. Business Investment and Innovation White Paper from Senate Finance.
- On May 6, 2013, the House Ways & Means Committee issued a report summarizing of all comments received by the eleven Tax Reform Working Groups formed by Chairman Camp. Both the repeal and a simplification of section 1031 were mentioned.
All tax expenditures, including IRC Section 1031, are likely to be on the table as potential revenue raisers for tax reform. The Joint Committee on Taxation recently estimated the tax expenditure for Section 1031 like kind exchanges at $42 billion over the 5 year period 2012-2016. This estimate is almost three times last year's estimate of $15.2 billion. This places Section 1031 exchanges among the top ten expenditures and makes it a substantially larger target as a potential revenue raiser for tax reform. Recently, several commentators and opinion pieces have referenced Section 1031 as an unfair loophole or abusive tax avoidance scheme.
The Government Affairs Committee of the FEA has already stepped up its efforts to rebut the misinformation about Section 1031, and to create awareness that Section 1031 is a powerful economic stimulator that benefits a broad base of taxpayers. It is not an unfair loophole or abusive tax avoidance scheme. We cannot do the job alone. We need all of you as this affects the real estate industry as a whole.
For a sample letter from the FEA that you can customize and send directly, click here.
For a brief sample letter from 1031 CORP., click here.
For your reference and talking points, please review the FEA's whitepaper, "Impact of Section 1031 on the Economy."
Instructions for Sending Electronic Letters:
For the Senate Finance Committee: Email your letter to the Chief of Staff asking him to forward your letter to the Senator. Copy the Executive Assistant and the Senate Finance Committee Tax Counsel. Please send a separate email to each group.
For Chairman Max Baucus:
To: Chief of Staff Paul Wilkins (email@example.com)
cc: Executive Assistant Anthony Lopez (firstname.lastname@example.org)
cc: Senate Finance Committee Tax Counsel Holly Porter(Holly_Porter@finance.senate.gov)
For Ranking Member Orrin Hatch:
cc: Executive Assistant Ruth Montoya (email@example.com)
cc: Senate Finance Committee Tax Counsel Mark Prater (firstname.lastname@example.org)
Thanks to all of you for your efforts and support. 1031 CORP. continue to keep you updated.