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Proposed Tax Reform Includes Ending 1031 Exchange

Proposed Tax Reform Includes Ending 1031 Exchange

The ninety two year old 1031 exchange statute is once again the target for abolishment in current tax reform proposals. Congressman Dave Camp, Chair of the U.S. House of Representatives Committee on Ways and Means, has a bipartisan tax reform group tasked with identifying eleven subjects including real estate tax matters as potential revenue raisers. Senator Max Baucus, Chair of the Senate Finance Committee has targeted the elimination of the 1031 exchange as one of many means of tax reform.

Section 1031 “like-kind” exchanges is estimated to cost over $42 billion over the five year period 2012-2016 by the Joint Committee on Taxation (JCT). Estimates by the JCT in prior years estimated the tax deferral to be $16.2 billion over the five year period 2010 – 2014. The two fold difference is attributed to a change in accounting methodology.

The Treasury Department 1031 Regulation is enforced by the Internal Revenue Service in Section 1.1031 stating that “no gain or loss shall be recognized on the exchange of property held for productive use in trade or business, or investment, if such property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.” Individuals, marrieds, partnerships, trusts, corporations use 1031 exchanges when selling and replacing real and personal property to defer federal and state capital gain and recaptured depreciation taxes. The taxes are deferred until the replacement property is sold and not replaced, effectively cashing out. The economic position of the taxpayer does not change in a 1031 exchange; they have the same amount of cash and debt if not more. If the taxpayer receives cash or reduction in debt, then a tax is due.

Sixty percent of 1031 exchanges involve properties for sales of less than one million dollars with a third for less than $300,000 owned by small investors and businesses. As a Qualified Intermediary the majority of my clients are individuals and small businesses with exchange proceeds of less than $300,000. Corporate entities do utilize 1031 exchanges to replace worn equipment and reposition low income producing properties with higher income producing properties. In the Florida Panhandle, from Perdido Key west of Pensacola, Florida to Panama City Beach, Florida, investment properties saturate the real estate market with the local counties benefiting from the county bed taxes on properties held for short term rentals. Titleholders are individuals, husband and wives, trusts and small limited liability companies generating business for Realtors, lenders, contractors, title companies, attorneys, CPAs, appraisal, pest and survey companies.

Positive Impact of 1031 Exchanges

  • Encourages the rate by which money is moved from one transaction to another; otherwise, known as the velocity of money.
  • Property located in the U.S. must be exchanged with property located in the U.S. requiring reinvestment in the U.S. rather than overseas.
  • Stimulates taxpayers to acquire properties of equal or greater value often times greater including improvements in real estate.

What a 1031 is Not

  • A tax loop hole for the rich. Having accommodated over 630 simple and complex 1031 exchanges, ninety percent of my clients are individuals, families and trusts within seven hour driving radius of Destin, Florida.
  • A tax scheme robbing U.S. taxpayers and government, rather a temporary tax deferral with the tax due when replacement property is cashed out or due upon decedent’s taxable estate.

Negative Impact of 1031 Exchange Elimination

  • Fewer real estate transactions; real and personal property will be held longer with many families electing to hold until death.
  • Increase in depreciation deductions offsetting income tax revenue.
  • Businesses will down size due to no longer having access to or qualify for loans and paying tax on the gain or depreciation recapture of relinquished or old asset.

1031 exchanges provide significant benefits to the taxpayer and local economies where the asset is located encouraging reinvestment versus the hoarding of cash and removing those dollars from the economy. The 1031 exchange allows many others, including myself to benefit in the transaction before ultimately deposited with the US Treasury.

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About the author

Andy Gustafson, CES

Andy Gustafson, Certified Exchange Specialist®, is a managing member of Atlas 1031 Exchange, LLC, a nationwide accommodator of Internal Revenue Code Section 1031. He founded the company in 2007, and has since expanded his professional services into Texas and the Midwest. He has spoken to hundreds of investors at Wealth Camps and Real Estate Investment Clubs nationwide and is a sought after speaker on the topic. As an approved continuing educational provider, he has helped hundreds of Realtors, Attorneys, and CPAs understand the application of the 1031 code. To date he has accommodated over 500 exchanges representing $433,000,000 in exchanged value and deferring over $22,000,000 in taxes.

10 Comments

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  • Andy, thats a great article but you know as well as I do that the idiots in Congress will absolutely make this about a loophole for the wealthy. They are only interested in generating more taxes to spend on their pork project nonsense. If Congress actually cared, they would cut spending and they wouldn’t keep raising the debt limit every chance they get.

  • What is the liklihood of this actually happening, and if it does, when do you think it would become effective? Thanks,

    Ronnie

    • As to the probability of this happening perhaps 60 percent given the bi-partisan support and tax reform gains traction in Congress. It would become effective in the following fiscal year of signing or 2016.

  • Thanks I will pass that on to someone who took advantage of it in the past and said they would do so again after the “waiting” period, whatever that was.

  • Andy – nice post, very well written. IMO if congress wants to increase revenue, lower the long term capital gains rate. More investors would opt to cash out and pay the tax. Abolishing 1031 will stop a certain market segment in it’s tracks and have no effect on tax revenue.

  • Would this take a legislative change or simply regulatory change? Do you have a link to website that is tracking this proposed regulation/legislation?
    Also does this “reform” also include abolishing the treatment of capital gains from an “involuntary conversion” allowed in IRS Sec 1033?

    • The change would require a legislative action. No, I don’t know of a website tracking the change, however, I am in contact with lobbying efforts to educate legislators on the benefits of 1031 exchanges. Section 1033 covering immanent domain or transfer by condemnation would not be impacted, my assumption.

  • The key here that Congress fails to grasp is that 1031 exchanges are a “deferral” of taxes, not an “avoidance” of taxes. Tax loopholes on the other hand almost always involve tax avoidance. It has been my experience as a licensed real estate broker that properties that were acquired in a 1031 exchange have appreciated in value. Ultimately upon disposal they garner more revenue for the taxing authority than they would have otherwise.

  • Andy, In the “5 rules” article, 2004 had 73 billion in exchange deferred monies. 2011 had only 2.5 billion. Why the huge difference?

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