Erin Crowley
Colorado division manager, Asset Preservation Inc., Denver
Like-kind exchanges under Section 1031 have been a vital part of the tax code since 1921. The capital gain inherent in the relinquished party is not taxed upon its transfer. However, since the basis of the relinquished property becomes the basis of the replacement property, the capital gain tax is not eliminated; it is merely deferred until the replacement property is sold, or exchanged for nonlike-kind property.
Scott R. Saunders
Senior vice president, Asset Preservation Inc., Palmer Lake
Section 1031 is not a loophole. The capital gain tax is not avoided – it is merely deferred. This outcome is based on sound tax policy. The logic is that the investor, in exchanging one appreciated property for another like-kind property, has not realized the gain inherent in the relinquished property. The investor has merely changed the form of the investment. Section 1031 accurately reflects the economic reality of investment continuity in which no profit is realized, thus there is no premise for taxation.
In light of challenges passing health care reform, President Trump and Republicans who control majorities in the House and Senate politically need to achieve success on important agenda items. Comprehensive tax reform is a central objective of Republicans. Many people feel that if tax reform does not happen when Republicans control the executive and legislative branches of government, meaningful tax reform is virtually impossible to achieve.
In June 2016, House Republicans released their “Blueprint” for tax reform. Although the Blueprint does not mention exchanges, it does propose a significant tax change allowing investors to immediately expense a purchase. Instead of depreciating a property over time, expensing would allow for the immediate deduction of the property improvements (but not the value of land) and some representatives in Congress feel this eliminates the need for 1031 exchanges. The Blueprint proposes simplifying from today’s seven tax brackets to three brackets (12 percent, 25 percent, 33 percent). The Blueprint also proposes a 20 percent corporate tax rate, a 50 percent exclusion on capital gains and eliminating the 3.8 percent net investment income tax. President Trump also has proposed lower tax rates but with slightly different rate targets that include a 15 percent corporate rate, 20 percent capital gains tax rate and eliminating the 3.8 percent net investment income tax.
Congress will use the 2018 Budget Reconciliation process to tackle tax reform. Instead of following regular order (the normal bipartisan legislative process), the Republican-controlled Congress will only need a simple majority to move legislation forward using budget reconciliation. The Trump administration has stated that it hopes to roll out a detailed tax plan this month. All tax bills must originate in the House; the Committee on Ways and Means will prepare the text of a tax reform bill and then the full House will vote on this bill. Next the bill advances to the Senate, where the Senate Finance Committee will prepare its tax reform bill, which will be voted on by the Senate. Finally, a Conference Committee will work to reconcile the differences between the two bills and send the final tax reform bill to President Trump. Kevin Brady, R-Texas, chair of the House Ways and Means Committee, has said he believes all this can be accomplished before the end of 2017. Other congressional representatives are not as confident that comprehensive tax reform can be accomplished in such a short time period.
For tax reform to be permanent, it must be revenue neutral. Any reduction in tax rates must be offset by eliminating other tax benefits elsewhere in the tax code. If congressional representatives are unable to agree on what tax benefits to cut, another alternative is passing temporary tax cuts that would expire after 10 years.
Although the Joint Committee on Taxation projected receiving $4 billion per year in new tax revenue by repealing Section 1031, two recent studies show the negative impact on the economy will be far more than this amount. An Ernst & Young study showed the repeal of Section 1031 would result in a $13.1 billion per year reduction in gross domestic product. The Tax Foundation shows a direr outcome with an $18 billion annual loss of GDP.
Proposals to repeal Section 1031 appear to be based on calculations that do not consider the reality that, if investors are unable to defer gains in a 1031 exchange, many prospective sellers will simply hold their properties and not sell at all. Most of the projected additional tax revenue will never materialize because investors will hold their property rather than face a sizeable tax consequence. The net impact would be a large decrease in transactional activity and a significant reduction in investment property inventory. This would result in reduced business for commercial brokers and also have a negative impact on jobs across a wide array of ancillary services that reach far beyond the real estate sector.
The repeal of Section 1031 would lead to a decrease in property values as investment properties become more illiquid. This loss of equity in real estate would dampen spending and investment in the economy overall, which would ultimately result in lost jobs, increased unemployment and billions of lost revenue for both states and the federal government.
A broad coalition of over 100 industry organizations including the National Association of Realtors and the Federation of Exchange Accommodators has been working diligently to educate Congress on the economic activity and job-stimulating aspects created by this powerful tax code section. The website 1031taxreform.com provides an efficient method to easily contact your representatives and express support for 1031 exchanges.
