1031 Tax Reform Updates
Impact of the Tax Cut and Jobs Act on Sec. 1031
The Tax Cut and Jobs Act was signed into law on December 22, 2017, and took effect on January 1, 2018. It is a complex modification to the Internal Revenue Code that will take some time to fully understand, notwithstanding that it became effective just nine days after signing.
The major change to Section 1031 is the complete repeal of personal property exchanges. The Code section now refers exclusively to real estate assets, and has been retitled, “Exchange of real property held for productive use or investment.”
Real estate exchanges are subject to the same rules and regulations as under previous law. The 45 day identification and 180 day exchange periods remain unchanged, as does the role of the Qualified Intermediary. All real estate in the United States, improved or unimproved, also remains like-kind to all other domestic real estate. Foreign real estate continues to be not like-kind to real estate in the U.S.
Personal property assets that can no longer be exchanged include intangibles, such as broadband spectrums, fast-food restaurant franchise licenses and patents; aircraft, vehicles, machinery and equipment, railcars, boats, livestock, artwork and collectibles. Transition rules permit a personal property exchange to be completed in 2018 if either the relinquished property was sold or the replacement property was acquired by the taxpayer during 2017. Note that there is no mention in the transition rule of acquisition by an EAT; the rule is specific to the taxpayer.
Full expensing. The full cost of tangible business use personal property assets such as heavy equipment, farm machinery, vehicles and hotel furniture can be written off in the year that they are placed in service by the taxpayer. Although tax can no longer be deferred through like-kind exchanges for these assets, the full expensing deduction can be used to offset any capital gain or depreciation recapture recognized in that same or future years. Full expensing is temporary; it will expire in 2022, and will be reduced to 80% for assets placed in service in 2023, 60% for 2024, 40% for 2025 and 20% for 2026. This deduction applies to both new and used assets acquired by the taxpayer.
Continuing risks to Section 1031 will come from a change in both Members and the balance of power in Congress, and from efforts to correct flaws in this hastily passed tax bill. Since the bill was not revenue neutral, and increases the deficit by almost $1.5 trillion over the 10-year budget window, any changes must be paid for with an offsetting reduction. We successfully made the case that Section 1031 should be preserved because it stimulates the US economy and benefits taxpayers of all sizes. However, that message will need to be delivered again as pay-fors are sought for corrections and the make-up of Congress changes after the 2018 elections.
Many thanks go out to all who tirelessly helped throughout this process of advocating for preservation of Section 1031 through meetings, calls, letters and more. Without all of our voices informing Congress of the broad benefits of Section 1031, this important tool could have been eliminated in its entirety. Everyone helped and every bit of help mattered. Congratulations to us all!
We are especially grateful to all of the Members of Congress that listened, understood, and supported retention of Section 1031 in this tax reform bill.
When investors or businesses structure their real estate sale and replacement purchases as §1031 Like-Kind Exchanges, they are able to defer payment of capital gains and recapture taxes. The like-kind exchange is a powerful tool that encourages people and entities to re-invest their profits into more productive property that is better suited for current and future needs, stimulating business and economic growth. (See What is a 1031 Exchange infographic)
In some U.S. markets, real estate brokers claim that §1031 exchanges touch at least 45% of the real estate investment transactions. Eliminating the option of structuring transactions as like-kind exchanges would not only cause a sharp drop in real estate transactions, but the additional business and services generated from the transactional activity related to §1031 exchanges would fall as well. In 2015, Ernst & Young, LLP released a macro-economic study on the impact of repealing or limiting 1031 exchanges that quantified that the US economy would actually contract if §1031 was repealed or limited, finding that GDP would be reduced by $8.1 billion or more per year. (Repeal of 1031 Exchange infographic).