Tax Deferred 1031 Exchanges – Is the End in Sight?

Tax reform is a hot topic in 2017. Donald Trump has identified tax reform as one of his top priorities and it is expected that house republicans will begin to push legislation looking to create visible changes to the tax code. Is the end in sigh for tax deferred 1031 exchanges?

Lawmakers are eyeing bills to change the current tax code including abolishing the much loved 1031 exchange, a section of the tax code which allows for the deferment of taxes when selling a property if a similar property is purchased.

Here are a few things you should know about section 1031 of the internal revenue code:

  1. A 1031 exchange allows taxes to be deferred in something called a property swap. A seller can defer any taxes owed on a property sale by purchasing another property “of like kind”. Gains accrued from the sale of the property are not recognizes immediately. Instead the gains are deferred until the (new) replacement property is sold, at which point the cash will be taxable.
  2. Property swaps are popular among smaller entities. Individuals with rental properties, or small real estate companies commonly use a 1031 exchange to use pre-tax profits to help purchase new properties.
  3. People disagree on the impact of the policy change. Those who want to remove the 1031 exchange section from the tax code see it as a simple tax loophole benefiting the rich. Removing the section would create immediate financial gain for the government, potentially allowing for other taxes to be decreased.
  4. Proponents of the deferment point to the fact that decreasing tax liability for those involved in trading real estate means that they then have more capital to spend on improving the properties. Not only will the removal of this provision mean that fewer sales occur overall, but that once the sales have been completed, there will be less spending on other areas, which increase the value of the property and support local business.

The 1031 exchange tax law always made sense to me. Sell a property and use the gross profits towards purchasing a new property and pay taxes when you cash out and in the meantime add liquidity to the market. No law is perfect but most people seemed to favor this one.