Financing Focus

Like-Kind Exchanges

IRC Section 1031 stimulates the economy, simplifies taxes, and isn’t a loophole.

Internal Revenue Code Section 1031 exchanges are powerful economic stimulators that are grounded in sound tax policy. Current tax reform goals are to stimulate the economy, simplify the tax code, and eliminate loopholes, according to the Trump administration.

Section 1031 meets the first two goals, without being a loophole. Since it allows the deferral of tax on capital gains, 1031 like-kind exchanges stimulate the economy by encouraging both investment real estate transactions and the replacement and upgrading of businesses' machinery and equipment.

Check out CCIM's upcoming course on 1031 exchanges.

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By deferring capital gain recognition, 1031 like-kind exchanges help transfer properties into the hands of new owners with the ability to restore and improve them. Without Section 1031, many of these properties would languish - underused and underinvested - because of the tax burden that would apply to an outright sale.

Section 1031 is neither a loophole nor a tax savings vehicle, but rather a powerful economic engine based on sound tax policy. The nonrecognition exchange policy is based on the understanding that the taxpayer continues with the same qualifying investment, with no intervening receipt of cash, and is left in the same tax position as if the relinquished asset was never sold.

This valuable tax-deferred exchange should be retained in its current form. It accurately reflects the economic reality of investment continuity in which no profit is taken, so there is no premise to tax.

Capital Formation and Liquidity

This nearly century-old tax policy permits efficient use of productive capital and cash flow, while allowing taxpayers to shift to more productive like-kind property, change geographic locations, diversify, or consolidate holdings. Tax-deferred exchanges provide a vital stimulus to a multitude of economic sectors, having local, national, and global effect.

It is evident that Section 1031 promotes capital formation and liquidity. A macroeconomic impact study by Ernst & Young and a microeconomic impact study on commercial real estate by David C. Ling, Ph.D., at University of Florida, and Milena Petrova, Ph.D., at Syracuse University, both published in 2015, concluded that Section 1031 removes the tax lock-in effect and permits taxpayers to make good business decisions without being impeded by negative tax consequences.

Like-kind exchanges stimulate economic activity and promote property improvements that benefit communities, increase property values and local tax revenues, improve neighborhoods, and generate a multitude of jobs ancillary to the exchange transactions. These studies quantified that restricting or eliminating like-kind exchanges would result in a decline in gross domestic product of up to $13.1 billion annually, reduce velocity in the economy, and increase the cost of capital to taxpayers. A 2016 Tax Foundation report estimated an approximately $18 billion annual economic contraction.

1031 exchanges contribute significantly to the velocity of the economy and promote investment in U.S. property. Owners of investment real estate are encouraged by the tax benefits to reinvest in U.S. real estate. Also, Section 1031 provides a strong incentive to multinational companies to maintain and increase investments in the U.S. investment property markets.

Investment Taxpayers

Like-kind exchanges benefit the economy in multiple ways. Commercial real estate owners, individuals, and businesses of all sizes use like-kind exchanges to trade up to larger facilities. The ability to take advantage of good business opportunities stimulates transactional activity that generates taxable revenue for many professions, including brokers, lenders, appraisers, surveyors, inspectors, insurers, attorneys, and accountants.

This transactional velocity also creates opportunities for smaller  businesses to acquire entry-level facilities and used equipment from which to launch and grow their fledgling businesses.

Like-kind exchanges remove friction from business transactions and stimulate economic activity for all business investment taxpayers. Section 1031 facilitates opportunistic investment of capital and community improvement.

Like-kind exchanges assist the recycling of real estate and other capital to its highest and best use in the marketplace, thereby creating value and improving economic conditions for local communities - rural and urban.

A broad spectrum of taxpayers would be harmed if they had to pay taxes for moving their investment or reinvesting their business assets. Section 1031 meets the current tax reform goals perfectly. It's not a loophole, but a simple and sound tax policy that has been stimulating economic growth since 1921. It needs to be retained.

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Bill Horan

Bill Horan is the owner of the Realty Exchange Corp. in  Gainesville, Va. Contact him at bill@1031.us.

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