Possible Unintended Outcomes if 1031 Exchange is Altered

Topics: Archive

Eliminating the use of Section 1031 of the Internal Revenue Code by certain high net worth investors could negatively impact individual investors, small business owners, and the overall economy.

During his presidential campaign, Biden proposed a package that includes using the estimated $50 billion in tax revenues generated from eliminating 1031 exchanges, for investors with a net worth of over $400,000, to pay for improved childcare and healthcare for seniors.

These initiatives aiding vulnerable populations hit hardest by the COVID-19 pandemic are keys to Biden’s economic recovery plan, but there may be better funding sources.

Just as investors may reap long-term benefits from 1031 exchanges by deferring capital gains and depreciation taxes, the economy realizes far-reaching, long-term benefits from the process as well. From jobs, to taxes, and financial security, Section 1031 of the Code is an engine for growth that pays for itself many times over.

When politicians look only to capture the deferred taxes, they may take an overly simplistic view of the 1031 exchange process and ignore the vast positive upstream and downstream effects.

Jobs, jobs, and more jobs

1031 exchanges aren’t just paper transactions involving a single investor looking to defer tax payments. Instead, the investor is able to use the funds that otherwise would have been earmarked for taxes to make upgrades on the property, diversify holdings, and improve their community. Spending at home improvement stores and building supply outlets funnels tax revenues back into local economies.

Typical home improvement projects involve architects, contractors, electricians, plumbers, laborers, and others. Completing a 1031 exchange involves a network of professionals including qualified intermediaries, lawyers, appraisers, and escrow agents. All pay federal and state income taxes.

Research has shown there would be a clear negative impact to the economy should 1031 exchanges be eliminated.1 A 2015 Ernst & Young study found that repealing 1031 exchanges could shrink the economy by more than $13 billion, discourage investment, and lower tax revenues.

Time to understand how far 1031 exchange benefits reach

A big part of the fight for 1031 exchanges involves the lens through which they are viewed. Instead of looking myopically at the immediate tax gain missed during a real estate transaction, taking a broader view makes it clear why this statute has been around for 100 years.

Individual investors and small businesses are among the biggest users of 1031 exchanges. It can be a path to a secure financial future, a key financial planning tool, and an income stream for retirement.

Don’t forget the farmers

Farmers are an often a forgotten segment of 1031 exchangers. Because farmers often have had land passed from generation to generation, they are in a unique position to use the provision to secure their futures and assist their communities.

They are able to sell land that is no longer productive for farming to aid conservation efforts by selling easements that restrict crop production or other farming activities. They can also exchange property for non-farm property investments to protect multi-generational wealth.

Education before action on 1031 exchanges

It is important to take a good look at the 1031 exchange and fully understand the value of this 100 year old section of the tax code before taking any action.

The ability to defer taxes by reinvesting the proceeds from the sale of one property into another gives investors flexibility to spend more on property improvements, secure the income needed to last through retirement, accumulate generational wealth, generate jobs, and fuel economic growth.

In the midst of a pandemic and a struggling economy, it may be the wrong time to consider eliminating certain property owners' ability to perform a 1031 like-kind exchange. While programs that help children and seniors have universal appeal, funding them through the elimination of the IRS Section 1031 exchange has the potential to provide a short-term bump while unintentionally limiting long-term prospects.

1 Ernst & Young 2015 study results: http://www.1031taxreform.com/wp-content/uploads/EY-Report-for-LKE-Coalition-on-macroeconomic-impact-of-repealing-LKE-rules-revised-2015-11-18.pdf

If you would like more information about the benefits of 1031 exchanges, please contact us today.

New call-to-action