1031 Exchange Properties – Some Recent Developments
Since 1921, Internal Revenue Code (IRC) §1031 has provided a means for investors to defer taxes on capital gains from the sale of business or investment property by reinvesting the sale proceeds to purchase other investment property. As set forth in IRC §1031 (a)(1), “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind investment.” Since its inception, Section 1031 has undergone only minor modifications, and has been widely recognized as sound tax policy, both because it is based on the premise that continuity of investment by the taxpayer is desirable, and also because it works well for taxpayers across the economic spectrum, from the small individual investor to the large corporation.
Why, then, is the White House and Congress now proposing legislation that could abolish Section 1031? Currently, three different proposals have been advanced that would either severely restrict tax deferrals on gains from the exchange of like-kind property, or would repeal like-kind exchanges under Section 1031 altogether. The House Ways and Means Committee’s draft Tax Reform Act of 2014 calls for the repeal of Section1031, claiming that such a move is necessary to attain a 25 percent corporate tax rate that would, “increase global competitiveness, encourage investment in the United Sates, and bolster job growth and the economy.” (Ref. Summary document, p. 50). The proposed repeal would cover all contracts signed after December 31, 2014, grandfathering like-kind exchanges contracted on or before that date and completed prior to January 1, 2017. According to the Joint Committee on Taxation, the repeal would increase revenues by an estimated $40.9 billion through 2023. Section 1031 proponents counter that, taking into consideration the impact of depreciation and the economic stimulus that like-kind exchanges provide, their elimination would neither result in increased revenue for the United States Treasury, nor bring substantive benefit to the U.S. economy.
A second draft proposal, the Senate Finance Committee Discussion Draft: Cost Recovery and Accounting, would also abolish Section 1031, again based on the argument that doing so will generate revenue. However, language in this draft suggests that the door be left open for the continuation of real property exchanges, provided that the standards for like-kind exchanges are narrowed to require that the properties exchanged be similar in service or use. The length of the depreciation period for all real property would also be extended to 43 years, a four-year increase for non-residential property, resulting in reduced annual deductions for depreciation.
Finally, the President’s proposed 2015 Budget contains a provision that would limit the capital gain deferral for real estate exchanges under Section 1031 to $1 million (indexed for inflation) per taxable year per taxpayer, effective for all exchanges completed after December 31, 2014. While this proposal would likely allow many small businesses and individual investors to maintain their current 1031 exchange practices, its severe limits on the amount of real estate gain eligible for deferral would have a chilling effect on large investors and corporations.
While the proposals summarized above are all still only proposals, they each have the potential to destroy or, at the very least, severely compromise a section of the tax code that has worked well for nearly a century and, according to Section 1031 proponents, is consistent with the goals of achieving efficiency, neutrality, fairness and simplicity within the tax system. While the government argues that like-kind rules can be vague enough to result in widespread abuse, 1031 exchange advocates counter that like-kind exchanges benefit millions of Americans annually while encouraging business expansion and reinvestment, and keeping real estate values solid. Some even predict that a repeal of Section 1031 will result in punitive tax increases on commercial real estate investment, driving investors to other types of investments, lowering real estate values, and, in all likelihood, leading to yet another recession.
The Federation of Exchange Accommodators, an industry trade group, has submitted comments in support of Section 1031 to the Senate Finance Committee, the House Ways and Means Committee and the Treasury Department, and urges all real estate investors to contact their representatives in Congress and make it known that longstanding provisions for like-kind exchange of business and investment property must remain in the tax code.
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Disclaimer: 1031 exchange made simple does not guarantee the performance of the QI's in our referral network and we can not be held liable for any misrepresentations or mistakes in regards to a 1031 exchange by one of the QI's that we refer to you. 1031 Exchange made simple does not provide tax advice nor can we make representations regarding the tax consequences of an exchange transaction. 1031 Exchange made simple is a 1031 QI Referral Network. 1031 made simple is not responsible (in any way) for the performance, creditability, and financial condition of any QI in our network. In this new economic environment it is imperative that all potential 1031 exchange customers do their own due diligence and research on any QI that they may use, on a 1031 exchange. Please verify and check the validity of the Bonding and Insurance of your QI. It may be wise to have your 1031 exchange accounts set up as separate, individual customer accounts. Our web site is to be used as a information based web site only. All parties doing a 1031 exchange must consult their tax advisors or attorney for this information.
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