In our most recent post, we highlighted what is at stake in this presidential election for investment property owners and investors who use the 1031 exchange – a nearly 100-year old Internal Revenue Code-compliant approach – to deferring taxes as an important approach to growing and preserving personal wealth.
In that discussion, we mentioned how the 1031 exchange has been under political scrutiny before by both political parties, but this valuable piece of the tax code has continued to survive relatively unscathed through many election cycles. This time, however, it could be different.
We thought it would be helpful and informative for us to provide a different perspective in this post on a few key points politicians might not be familiar with, and that is the broad economic impact and benefit the 1031 exchange provides. To name just a few as, noted by the Federation of Exchange Accommodators:
Like-Kind Exchanges Stimulate Business Growth of All Sizes
Small and mid-size business owners and middle-class taxpayers use Section 1031 to transition into facilities and locations that more efficiently meet their needs. These exchanges allow taxpayers to shift to more productive like-kind property, change geographic location, and diversify or consolidate holdings.
Like-Kind Exchanges Stimulate Needed Capital Investment
From the fallout of the coronavirus pandemic, large amounts of retail and office space will likely become vacant or underused as businesses transition to different operating models. Like-kind exchanges encourage capital investment for the highest and best use of real estate, improving communities and increasing the local and state tax base.
Like-Kind Exchanges Help Repurpose Available Real Estate
According to a 2015 study by Professors David Ling and Milena Petrova, Section 1031 like-kind exchanges give businesses and entrepreneurs more incentive and ability to make real estate and capital investments. In addition, taxpayers engaged in a like-kind exchange invested 33% more capital in replacement property than non-exchanging buyers.
Like-Kind Exchanges Create Jobs
These investments also generate jobs and taxable revenue for unrelated businesses upstream and downstream from the exchange transaction, such as real estate agents, title and property insurers, escrow / settlement agents, lenders, appraisers, surveyors, attorneys, inspectors, contractors, building supply vendors and more.
Like-Kind Exchanges Help Family Farmers
Farmers and ranchers use Section 1031 to relocate, consolidate or help improve their operations without diminishing their cash flow potential.
A few other interesting points that might go unnoticed by politicians who may be challenged very soon with considering the merits of 1031 exchanges if new legislation is presented:
- Section 1031 exchanges benefit commercial real estate by allowing companies to keep cash in their businesses, enabling these firms to adjust their real estate holdings to changing situations and business needs without requiring them to cash-out every time.
- Section 1031 exchanges can improve the tax base by generating transactional and permitting fees, benefitting tax revenue at the state and local level.
- In the widely cited Ling Petrova study, 88% of real estate properties acquired in an exchange are later sold in a taxable transaction, not a subsequent exchange. Bottom line, the government gets its share. 1031 exchanges are not a tax haven for the rich.
Granted, the 1031 exchange might be unfamiliar to many voters, and the topic of retaining or repealing this Internal Revenue Tax code might garner little attention in this season of fevered rhetoric, but the ramifications of changes to the code are large and worthy of your attention.
Fortitude Investment Group continues to advocate for the 1031 exchange on behalf of our clients, partners, and the real estate investment industry. We encourage you to reach out to your legislators who you can locate here and share your support on this most important issue!
Please contact us with any questions!