The 1031 exchange survives tax reform: A roller-coaster year ends with tax code changes favorable to real estate investors
March 1, 2018
Section 1031 of the Internal Revenue Code was at serious risk of being eliminated by the Trump administration’s tax cut and reform plans, a threat that prompted the real estate industry to launch a major lobbying campaign to protect this important and long-standing provision. The good news is, following the intense lobbying campaign, congressional leadership concluded Section 1031 reflects sound tax policy and is good for the economy. As a result, real property exchanges were not affected by the Tax Cuts and Jobs Act of 2017, though personal property exchanges were eliminated effective Jan. 1, 2018.
Background: Early in 2016, the Obama administration proposed a $1 million per taxpayer per year limitation on the gain that could be deferred under Section 1031. While that proposal never saw the light of day, the perfect storm developed to create the potential for sweeping tax reform, with the White House and both chambers of Congress under Republican control. Later, Republican Kevin Brady, chairman of the influential House Ways and Means Committee, introduced a radical proposal to expense (write off) 100 percent of the cost of newly purchased assets. Republican leadership believed broad-based expensing made Section 1031 unnecessary, leading observers to believe Section 1031 was likely to be repealed if the Republican plan was adopted.
Context: Section 1031 has been in the federal tax code since 1921. Real estate exchanges account for about 30 percent of the $10 trillion annual real estate transaction volume. Because exchanges have become an integral part of the national economy, real estate trade groups and executives became very concerned that repealing Section 1031 would cause serious damage to the economy. According to Scott Saunders, a 1031 exchange intermediary with Asset Preservation Inc., there would have been “a big decrease in transactions, which would negatively affect many U.S. taxpayers and result in few jobs in ancillary services involved in the sale and purchase of real estate,” such as title companies, real estate agents and brokers. Eliminating Section 1031 also would have resulted in reduced income to municipalities from lost transfer tax revenue.
Intense lobbying: The leading real estate trade associations, including the Alternative & Direct Investment Securities Association, Federation of Exchange Accommodators, and National Association of Realtors, aggressively lobbied Congress in support of Section 1031. These organizations represent millions of real estate professionals across the country who are active participants in the real estate market.
Conclusion: The lobbying effort was effective in creating greater congressional awareness of the many public benefits of Section 1031, including substantial job production, forced savings, and the laudable goal of encouraging exchanges that result in property being used for its highest and best use. This experience demonstrated real estate trade groups and professionals must remain vocal and vigilant, even in the case of desirable, long-standing tax policy with a broad base of support.
Louis Rogers is founder and CEO of Capital Square 1031.
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