Over the last year, there have been many concerns about the proposal to effectively eliminate Section 1031 like-kind exchanges of real estate as a means to pay for President Biden's proposed American Families Plan.
It’s a myth that Section 1031 is a loophole or unfair tax break for corporations and the wealthy to avoid paying taxes.
On the contrary, Section 1031 is a powerful economic stimulator that is grounded in sound tax policy and an important tool used by businesses of all sizes, farmers, and middle-class taxpayers to transition into locations that more efficiently meet their needs.
The Congressional purposes for which Section 1031 was enacted in 1921 are even more relevant today in our global economy.
The COVID-19 pandemic has imposed unexpected, unprecedented trauma on commercial real estate - particularly retail, hotel and office space. A significant percentage of this property throughout the country will likely need to be repurposed. These are the types of large-scale projects that revitalize entire neighborhoods, generate significant job growth, and result in widespread community improvement.
The American Families Plan's proposed cap on like-kind exchanges at $500,000 is misguided because larger investors are critical to repurposing and renovating commercial real estate in a post-pandemic economy.
Section 1031 is an effective tool to encourage the highest and best use of properties, without disrupting markets, that allows individuals and businesses to continue contributing to their local communities, rather than them becoming shuttered blight. Section 1031 promotes efficient use of productive capital and cash flow. Limitation of Section 1031 would have a chilling effect on real estate, manufacturing and other business transactions.
Further, limitation of Section 1031 would tax cash flow, not wealth, because tax deferral benefits are only available if the taxpayer reinvests in like-kind replacement property. A taxpayer performing a Section 1031 exchange is not taking any profit from this transaction, but rather tax deferred proceeds from the sale of relinquished (old) real estate are only being reinvested in qualifying replacement (new) real estate.
More than just mere words, recent economic impact studies concluded that like-kind exchanges are a powerful stimulant of transactional activity that creates jobs, investment, local and Federal tax revenue, and contributes to the health of the U.S. economy. See e.g., David Barker, David C. Ling & Milena Petrova (2020): The Benefits and Costs of Tax Deferral: An Analysis of Section 1031 Exchanges, Journal of Real Estate Literature https://doi.org/10.1080/09277544.2020.1793578; Ernst & Young, LLP (May, 2021): Economic Impact of Repealing Like-Kind Exchange Rules https://thediwire.com/wp-content/uploads/2021/06/EY-FEA-Economic-activity-supported-by-LKE-rules-May-2021-Final-1.pdf
The foregoing studies found that exchanging buyers make real estate investments that are substantially greater than non-exchanging buyers, resulting in improved communities in which to live, work and play. These studies quantified that limiting or repealing Section 1031 would cause significant economic contraction and job loss.
Limitation of Section 1031 like-kind exchanges would not raise significant revenue and would be at cross-purposes with the stated goals of tax reform. Moreover, Section 1031 stimulates the agricultural sector and is used to promote conservation and environmental policies.
Lastly, under Section 1031, it is important to note that taxes are deferred, not eliminated. At some point, the tax gets paid. In fact, most replacement properties are later sold through a taxable sale, not through a subsequent like-kind exchange, per the Barker Ling & Petrova study cited above. Because of lower debt and greater capital investment rates, the taxes paid on sale of these properties are significantly greater than that of non-exchanged properties.
1031 CORP. and real estate professionals nationwide have urged Members of Congress, their policy advisors, and staff to preserve Section 1031 in full. You can voice your support and contribute to the cause of preserving 1031 exchange transactions for another 100 years at www.1031buildsamerica.com. We will continue our education and advocacy efforts to promote the benefits of 1031 exchanges that inure to everyone’s benefit. Please visit our website www.1031CORP.com and contact us regarding any questions or next steps in order to perform your next 1031 exchange.