Will IRS Section 1031 be Repealed?
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Section 1031 has been around since 1921, but will it make it to 2021? There are serious moves in congress underway to dramatically scale back or repeal the section on like kind 1031 exchanges and not just from Democrats.
As many folks know, IRS section 1031 allows an investor to defer the recognition of capital gains and resultant taxes on a relinquished property for another like kind replacement property. Section 1031 is not a loophole. It is merely a vehicle to defer capital gains tax until the property is cashed out or exchanged for a non like kind property.
The logic is that the investor by exchanging the capital gain for another like kind property has not realized the gain, but only changed the form of his investment
IRS section 1031 exchanges today are coordinated transaction in that the investor uses a qualified intermediary to facilitate the sale of the relinquished (down leg) to one party and replaces it with the replacement property (up leg) from another party. The capital gain in the transaction is not taxed until the investor cashes out at some point in the future or trades for a non like kind property. Since the basis for the relinquished property is still there, it is transferred to the replacement property to be taxed at some point in the future.
The above sounds great, but reality is that IRS Section 1031 is under threat. There are currently three proposals to reduce or eliminate the benefits under section 1031 in Washington DC.
Former senator Max Baucus (D-Montana) proposed lengthening the depreciation schedules from 27.5 years for multiunit residential and 39 years for commercial property to 43 years for both and treating gains from real estate as ordinary income instead of capital gains.
Representative Rep Dave Camp (R-Michigan) chair of the House Ways and Means committee has proposed eliminating all section 1031 exchanges, period, beginning January 1, 2015,
The President proposes limiting the amount of capital gain deferred in a 1031 exchange to $1 million per tax payer.
The motivation of course is increased tax revenue. However, that well could be offset by markedly reduced transaction activity, which is already taxed at ordinary income rates such as reduced commissions for commercial brokers, but would also have a negative impact on jobs across a wide array of ancillary services that are also involved in exchange transactions.
Banks and commercial lenders would see reduced activity, as would title companies, escrow agents, appraisers, environmental companies, and many other services typically involved in commercial real estate transactions.
Repealing section 1031 would have a negative impact extending far beyond the commercial real estate industry resulting in reduced property values due to dramatically reduced transaction volume caused by properties becoming less liquid. Also imagine what this could do to property taxes, which benefit local schools.
Legislators must be educated that the 1031 exchanges promotes transactional activity, which creates jobs helping small and medium sized businesses and as a result increased tax revenue.
To help, contact your congress person and/or senator to express support for Section 1031 as it is, and the powerful economic engine that section 1031 is.
