§1031 Repeal threat is for real!

Octagonal stop sign with picture of raised handInternal Revenue Code (IRC) §1031 tax deferred like-kind exchanges has remained in the tax code since 1921, notwithstanding repeated Congressional scrutiny, because §1031 is based on sound tax policy that is predicated on continuity of investment by the taxpayer.

Section 1031 is consistent with goals of efficiency, neutrality, fairness, and simplicity within the tax system.

Recent proposals to reform the tax code have included a repeal of §1031, that if enacted, would negatively affect businesses and the U.S. economy. Section 1031 works well for, and is widely used by, a broad spectrum of taxpayers at all levels, in all lines of business, from small businesses to large corporations, and from individuals of modest means to high net worth taxpayers.

The Issue

Several Proposals Call for Repeal of §1031, Will Hurt TaxpayersTax reform proposals have been advanced by the House Ways and Means Committee, the Senate Finance Committee and the Treasury Department. Several proposals call for the repeal or restriction of tax deferral of gain from the exchange of like-kind property. One has been introduced as a bill.

This proposal has been introduced as a bill:

  1. Introduced as bill H.R. 1 in the House on December 11, 2014, the Tax Reform Act of 2014 calls for repeal of §1031. Status: Expired.

All of these proposals are presently in draft form:

  1. The Senate Finance Committee’s analysis report “Comprehensive Tax Reform for 2015 and Beyond” was released December 11, 2014, and does not call for a repeal of §1031, but lists like-kind exchanges as the third largest expenditure.
  2. The Treasury’s FY2015 Budget proposed limiting real property exchanges to $1 million annual gain deferral, but was silent about personal property exchanges.
  3. The Senate Finance Committee’s “Discussion Draft: Cost Recovery & Accounting” proposes to repeal §1031, but leaves the door open for real property and intangible property exchanges, and suggests a potential modification of the like-kind standard to the narrower §1033 standard requiring that the properties be similar in service or use.

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Repeal of §1031 is Bad for the Economy

The repeal of §1031 will cause a decline in real estate values as investors will be motivated to hold on to properties and to invest in more liquid, non-real estate investments with faster returns. The proposals effectively impose punitive and targeted tax increases on economically sound commercial real estate investment, the likely unintended consequence of which will be similar to implementation of 1986 tax reform modifications that resulted in a recession.

Section 1031 is Good for the Economy, and Good for Taxpayers

Like-kind exchanges contribute to the velocity of the economy by stimulating a broad spectrum of real estate transactions, and encouraging taxpayers to replace and upgrade machinery and equipment, thus stimulating purchases, sales, and manufacturing of machinery, equipment, vehicles and other assets. This deferral benefit permits efficient use of capital to preserve and manage cash flow, encouraging U.S. businesses to reinvest in their domestic operations, rather than offshoring business activity.

Elimination of §1031 would result in a tax on cash flow, not profit, because no profit is being taken out of the transaction. All proceeds are being reinvested in like-kind property.

The transactional activity stimulated by §1031 results in jobs in the real estate, construction, financial services, vehicle and equipment leasing, manufacturing, and other industries. Fewer transactions ultimately result in fewer jobs in these industries and in local small businesses that generate revenue from the after tax dollars of employed workers. Since domestic real estate and assets used predominantly within the United States cannot be exchanged for foreign based real estate and assets, §1031 directly stimulates reinvestment in U.S. communities and businesses, promoting job growth within our own borders.

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