“Should tax reform include the removal of Treasury Regulation Section 1031 tax deferred exchanges?” is a question that, for the misinformed, the answer appears to be “Yes.” The discussion underway is how to reform the tax code affecting billions of dollars of tax subsidies for individuals and corporations. As one of two hundred tax appropriations annually quantified by the bipartisan Joint Committee on Taxation, the 1031 exchange is estimated to cost $42 to $47 billion over a five year period. The manner in which these numbers are determined has changed tripling the previous $15 billion estimate. Here are the previous estimates:
Current activity, as revealed by lobbyist firm Williams and Jensen, includes:
- Joint Hearing on Tax Reform and the Tax Treatment of Capital Gains: Witnesses state 1031 “encourages inefficient behavior”
- Center on Budget and Policy Priorities: Call to reform Section 1031
- House Ways and Means tax reform working group: April 15 deadline for comments
- Senate Budget Committee holds hearing entitled “Reducing the Deficit by Eliminating Wasteful Spending the Tax Code: “1031 mentioned like-kind exchanges have grown into a major tax avoidance scheme for sellers of large assets such as commercial real estate or oil wells”
- Senate Finance Committee working internally on tax reform proposals
- Senate Finance Committee publishes white paper recommending tax reform efforts and giving consideration to the repeal, tightening or simplification (rollover) of Section 1031
- House Ways and Means Committee issues summary of Tax Reform Working Group comments where simplification of 1031 is mentioned
The premise is that the 1031 exchange favors the wealthy and not the general populace. To the contrary, over fifty percent of 1031 exchanges are for properties valued at $1,000,000 or less with one-third less than $500,000. The 1031 tax code is available to all taxpayers, providing an incentive to efficiently reinvest their proceeds into properties providing better cash flow, appreciation, depreciation and location. The majority of my clients are in the military, tradesman and professionals who use their disposable income to invest in land and investment single and multi-family properties. Businesses use 1031 exchanges as a source of additional working capital to replace worn out equipment.
The tax is deferred, not a grant to the taxpayer. Eventually, the capital gains and recaptured depreciation tax is paid to the Internal Revenue Service at current rates. Yes, there are exceptions, such as a charitable gift or at the taxpayer’s death, the property is stepped up in basis to the beneficiary.
Impact of Eliminating the 1031 Exchange
Though the perception of eliminating the 1031 exchange may differ from reality, the frequency of real and personal property transactions held in the productive use of a business or for investment would occur less often. Reduced frequency would lengthen the hold time of assets and reduce the business revenues for Realtors/Brokers, title companies, attorneys and of course qualified intermediaries. There could be less pressure for real estate to appreciate, business aircraft and equipment sales would diminish, further weakening manufacturing and ultimately employment and government revenue.
Qualified Intermediary
As a qualified intermediary, our role is to provide documents supporting the taxpayer’s intent to initiate a 1031 exchange, hold the funds such that the taxpayer is not in constructive receipt or has access to the cash and follow defined procedures as outlined in the 1031 code. The accommodator provides the taxpayer with guidance to be in compliance with the strict requirements of the 1031 code. The code requires the use of a qualified intermediary except in a two party exchange where the seller and buyer want each other’s property.
The 1031 exchange is a stimulus that has been reviewed multiple times by Congressional Committees producing changes in 1987, 1989 and 1991. What was found in the past is that the benefits outweigh the costs.
Click below to download “Ten Reasons Why a 1031 Exchange Makes Sense.”
