Threats to IRC Section 1031

The Biden Administration has proposed limiting Section 1031 like-kind exchange deferral to a maximum of $500,000 (single taxpayer) / $1 million (married taxpayers) in the budget proposal for 2025.

IPX1031, in conjunction with our trade association, the Federation of Exchange Accommodators (FEA), have built a strong defense with the 1031 real estate coalition, updated economic studies, hosted multiple congressional fundraisers, and attended numerous meetings with congressional staff to educate members of Congress. We will continue to fight for Section 1031.

Top Reasons to Preserve Section 1031

  1. Like-kind exchanges will accelerate our economic recovery from the pandemic by preventing real properties from languishing, underutilized and underinvested.
  2. Rules for like-kind exchanges are narrowly tailored and well-designed.
  3. Like-kind exchanges help small and minority-owned businesses expand and grow.
  4. Like-kind exchanges are an engine of job creation.
  5. Farmers, ranchers, and forest owners heavily rely on like-kind exchanges.
  6. Like-kind exchanges promote land conservation and environmental protection.
  7. Increasing the supply of affordable rental housing requires like-kind exchanges.
  8. States and localities depend on like-kind exchanges for tax revenue.
  9. For many Americans, like-kind exchanges are a principal tool for retirement savings.
  10. Like-kind exchanges reduce the cost of capital and make the economy more efficient.
  11. Additional federal taxes are collected in the years following a like-kind exchange.
  12. Like-kind exchanges help stabilize property values and real estate markets during an economic crisis.

1031 Exchange Impact Studies

Two studies that show the impact 1031 Exchanges have from both a macro (Ernst & Young) updated in 2022 and micro (Ling Petrova) level on the US economy released in 2021.  Further resources and white papers can be found here.

STUDYErnst & Young Macroeconomic Impact Study: Economic Contribution of the Like-Kind Exchange Rules to the US Economy in 2021 – Updated May 2022
read summary here
read full study here
EY Infographic on Economic Contribution of LKE

STUDY – Ling Petrova Microeconomic Impact Study: The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate
read summary here
read full study here

Read 1031Sustaining American Businesses (updated for 2022) here.

Will The 1031 Exchange Be Eliminated?

Time will tell if the 1031 is included as a pay for in upcoming legislation. Is there anything you can do right now to help?  Yes! Let your voice be heard.  Click here or the button below to send a letter to your U.S. Senators and Representative and let them know how important like-kind exchanges are to you and your clients. 

Read 1031 Talking Points here.

Continuing Threats to IRC Section 1031

Continuing risks to Section 1031 come from dynamic changes in Members of Congress and in the balance of power. While support for Section 1031 is bipartisan, so are the threats. The Tax Cut and Jobs Act (TCJA) was not revenue neutral, and increased the deficit by almost $1.5 trillion over the 10-year budget window. The COVID-19 pandemic-related stimulus packages have further increased the deficit by trillions more. The ongoing need for revenue to fund existing government expenses as well as new legislative initiatives stimulates the search on both sides of the aisle for “pay-fors” to offset these costs. 

Elimination of loopholes. Although not the first to call for this, the Biden presidential campaign has called for elimination of certain tax preferences for real estate and “loopholes,” which are reported to include capping the gain that can be deferred by Section 1031 like-kind exchanges. We have educated many in Congress, both Democrats and Republicans, that Section 1031 is not a loophole or an abusive tax-avoidance strategy, and that Section 1031 is instead a powerful stimulant to the US economy that creates jobs, but clearly, this is an ongoing challenge.

Immediate Expensing. The Trump Administration proposed immediate expensing (the ability to write off 100% of the full cost in the year of acquisition) for buildings as part of the TCJA.  Although the TCJA ultimately limited immediate expensing to personal property assets, the proposal, which would kill Section 1031, is still very much alive.  The real estate industry (including Qualified Intermediaries) opposes immediate expensing of real property improvements on the basis that it would disrupt real estate markets, and would increase speculative building and transactional activity intended to serve investor tax strategies, not occupant needs.  Conversely, Section 1031 provides the same tax-deferral, but in a non-disruptive manner that won’t lead to a bubble and burst.

Current Status of IRC Section 1031

The Tax Cut and Jobs Act (TCJA) which took effect on January 1, 2018 eliminated personal property assets, including tangible, intangible and living (e.g. breeding livestock, race horses) from IRC Section 1031 like-kind exchange treatment.  Section 1031 now applies exclusively to real estate assets, and has been retitled, “Exchange of real property held for productive use or investment.”

Proposed Regulations REG-117589-18. In response to the changes made by the TCJA, the IRS published Proposed Regulations on June 11, 2020 addressing the definition of real property. The Proposed Regulations clarified that definitions of real estate that are specific to other IRC sections do not apply for Section 1031 purposes.

The Proposed Regulations define real property qualifying for like-kind exchange treatment essentially as “land and improvements to land, unsevered crops and other natural products of land, and water and air space superjacent to land.”  Land improvements are further defined as “inherently permanent structures and the structural components of inherently permanent structures.” Lesser interests such as leaseholds and easements continue to qualify under Section 1031. Notable inclusions in the definition of real property are options to acquire real property and certain intangibles, including licenses and permits, that derive value and are inseparable from the real property, and contribute to the use of the subject real property, rather than production of income (except rent for use of the space). Finally, the IRS confirmed that with few exceptions, state law definitions of real property are not controlling for purposes of Section 1031.

Although the above definitions are pretty straight-forward, the IRS solicited comments related to a number of provisions in the Proposed Regulations. It is not known when final regulations will be issued.

Impact of the Tax Cut and Jobs Act on Sec. 1031

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.

Immediate 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.

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.

Why 1031 Exchange?

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, and improving communities. (See What is a 1031 Exchange infographic)

In some U.S. markets, real estate brokers claim that §1031 exchanges touch at least 40% 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. Similar microeconomic impact studies, focused on commercial real estate, by Professors David Ling and Milena Petrova, have further confirmed that if Section 1031 was eliminated or limited, transactional activity would diminish, the cost of capital would rise, the rate of investment would fall, holding periods would increase, property values would reduce, and rents would rise. (Repeal of 1031 Exchange infographic).

1031 Tax Reform Issues

IF Tax Reform Repeals 1031

Will a repeal of section 1031 accomplish the goals of tax reform set by Congress? NO!
  • Repeal of §1031 will not accomplish the goals of tax reform
  • Repeal of section 1031 will not increase fairness
  • Repeal of section 1031 will tax cash flow, not wealth
  • Repeal of section 1031 will not raise significant revenue
  • Repeal of section 1031 will cause a decline in real estate values, a drop in manufacturing, and economic stagnation
  • Section 1031 encourages reinvestment over profit taking, and it provides a strong incentive to keep that investment at home, in the United States.
Can retention of section 1031 laws help achieve goals set by Congress? YES!
The House Ways and Means Committee stated, “Every dollar small businesses spend on taxes and tax compliance is a dollar they do not have to invest in equipment, start a new production line, hire a new employee or provide more in wages and benefits.” (1) The Committee further posited, “Our outdated international tax system actually encourages American businesses to keep profits and jobs outside of America.” (2) The Committee concluded, “Simply put, if taxes were not so high…businesses would have the resources to reinvest in their businesses and help grow the economy of their communities.”(3)

The tax deferral benefit provided by section 1031 is a valuable tool for meeting all of these goals. It provides a powerful engine to the US economy. Like-kind exchanges promote transactional activity that results in jobs and taxable income that, in turn, fuels other businesses, including small and mid-sized businesses. And since foreign real estate and assets used predominantly outside of the United States cannot be exchanged for domestic real estate and assets such as machinery and equipment, the section 1031 deferral benefit directly stimulates reinvestment in US communities and businesses, promoting job growth within our own borders.

1 “The Tax Reform Act of 2014, Fixing Our Broken Tax Code So That It Works For American Families and Job Creators,” House Ways and Means Committee, p.11.
1 Ibid., p.9
1 Ibid., p.10

Is section 1031 a tax loophole? NO!
IRC section 1031 is a powerful economic engine based on sound tax policy. The non-recognition exchange policy is premised on the understanding that the taxpayer continues with the same qualifying investment, with no intervening receipt of cash, and is left in the same tax position as if the relinquished asset was never sold. This valuable section should be retained in its current form because it accurately reflects the economic reality of investment continuity in which no profit is taken, thus there is no premise to tax.
Is section 1031 an “abusive tax avoidance scheme?” NO!
Section 1031 provides only a temporary deferral; taxes are not eliminated. Tax will be paid either upon sale of the replacement asset, or incrementally, through increased income tax due to foregone depreciation, or by inclusion in a decedent’s taxable estate, at which time the value of the replacement asset could be subject to estate tax at a rate more than double the capital gains tax rate.
What are the risks of repealing section 1031?
  • Repeal of section 1031 will cause a decline in real estate values
  • Elimination of section 1031 would result in a substantial increase in depreciation deductions and reduced income tax revenue.
  • Elimination of section 1031 would have a chilling effect on real estate, manufacturing and other business transactions.
  • Fewer transactions also translate into fewer jobs not only in the 1031 Exchange industry, but also in the real estate, construction, title insurance, mortgage and other related industries, equipment lease financing, vehicle and heavy equipment rental and manufacturing, after-market alteration, customization and installation industries.
How would repeal of 1031 affect the cash flow of a business?
Elimination of section 1031 would tax cash flow, not wealth. Section 1031 permits a continuity of investment by the taxpayer without reducing cash flow available for growth of the business. The value of assets exchanged, whether farmland, commercial or rental residential real estate, machinery, equipment, vehicles or other business-use or investment assets, remains invested in the taxpayer’s business.

Without the current treatment under section 1031, cash-strapped owners of business-use and investment assets could be forced to downsize their businesses, farms, ranches, real estate holdings, etc. if they don’t have sufficient additional cash flow to acquire replacement assets and pay tax on the gain or depreciation recapture of the old asset.

Will longer depreciation schedules introduced by proposed depreciation pools unfairly impact taxpayers that are taxed at individual rates?
Unlike corporations, farmers, ranchers, real estate owners, and others holding assets in pass-through entities will be unfairly and negatively impacted by substantially reduced depreciation deductions coupled with individual tax rates that will be higher than the targeted 25% corporate rate. The effect of the depreciation pools is that depreciation for many assets will exceed the life of the asset. For example, farm equipment purchased at a cost of $300,000 which under current rules would be subject to 7 year MACRS, would be fully depreciated in its 8th year of ownership. That same unit of agricultural equipment, under the Pool 2 proposal, would not be fully depreciated until its 30th year of ownership, long after its useful life has ended. The combination of present MACRS depreciation rules with 1031 Exchanges provides a stronger cash flow benefit and therefore, a stronger economic stimulus to businesses. Elimination of section 1031 with a transfer to a pooling depreciation method will cause these individual taxpayers and small businesses to retain assets longer, since there is a reduced cash flow incentive to reinvest.

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