The Significance of 1031 Like-Kind Exchanges

To raise or not to raise taxes? It’s a debate as American as apple pie and old as time, which intensifies every election year. Recent discussions regarding changes to U.S. tax policy, including a new proposal from Democratic presidential candidate Joe Biden, have brought a small but powerful provision back into lawmakers’ crosshairs: the like-kind exchange.

Policymakers who want to raise tax revenue to pay for new public programs are contemplating the elimination of these exchanges for real property – a move that would not only be a net-loss for our economy, but which is actually more likely to decrease tax revenues in the future.

Like-kind exchanges, often referred to as “1031 exchanges” because of the relevant provision in the tax code, encourage reinvestment in the U.S. economy by deferring certain taxes on sales of property if the proceeds are reinvested in similar assets within 180 days. A proven driver of economic growth, like-kind exchanges are, according to The Wall Street Journal, “a cornerstone of the commercial real-estate industry.”

Sometimes policymakers are tempted to eliminate like-kind exchanges as a way to generate additional tax revenue to pay for other government projects. Such legislative dealing frequently disregards the return on investment these exchanges provide to the government by generating substantial economic activity and growth by encouraging the free flow of real estate capital.

It’s important to note that like-kind exchanges provide a deferral for taxes to be paid on the gains, not an outright elimination of taxation. Like-kind exchanges are sometimes looked to as pay-fors, not because they are unproductive or inefficient, but rather because they are not well understood. This misunderstanding leads to flawed policy. It’s like trading a $20 bill for a quarter – it doesn’t make economic or common sense.

At a moment when the U.S. economy is straining under the weight of the coronavirus pandemic, now is not the time to eliminate a proven driver of economic growth. Eliminating like-kind exchanges would substantially reduce many investors’ ability to remain invested in U.S. property. Like-kind exchanges provide immense support to an array of real estate investors spanning from individuals and small businesses to larger companies.

Small businesses need access to like-kind exchanges now, more than ever, to weather the current economic downturn. Today, struggling business owners can access capital by temporarily deferring tax on reinvested proceeds. If like-kind exchanges are eliminated, that would rarely be possible.

Exchanges also generate local and state tax revenue, create new jobs through labor-intensive property improvements, preserve a substantial amount of funds used for secure retirements and reduce the need for additional federal funding – all of which are under enormous strain during the pandemic.

According to a Section 1031 Microeconomic study from Professor David C. Ling of University of Florida and Professor Milena Petrova of Syracuse University, the elimination of exchanges would have a damaging effect on the value of U.S. real estate. The study reviewed more than 1.6 million commercial real estate transactions between 1997 and 2014 and found that like-kind exchanges lead to lower levels of debt in the real estate market. Despite some policymakers deeming the provision a loophole for investors to avoid taxation, the study showed that 1031 like-kind exchanges actually increase overall taxes paid to the Treasury.

For over 35 years, my organization has been a champion for like-kind exchanges, which have been an integral part of the U.S. tax code for nearly a century. As recently as 2017, Congress reevaluated the importance of like-kind exchanges and chose to retain and protect them.

Rather than limiting like-kind exchanges, I call on policymakers and campaigns to preserve them and consider how they can be leveraged to incentivize and advance commonsense policy agendas and socioeconomic developments our nation desperately needs.

Anthony Chereso is the president & CEO of the Institute for Portfolio Alternatives.

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