Why Like-Kind Exchanges Are So Important To The Real Estate Industry

The Internal Revenue Code Section 1031 allows taxpayers to defer capital gains payment and recapture taxes on the sale of property by reinvesting the proceeds in another property equal to or of greater value. It has existed for 100 years, yet many are unfamiliar with the Section 1031, and others are unaware of how important it is for creating jobs and generating tax revenue for the country.

Section 1031, also known as Like-Kind Exchanges, may be the focus of intense debate in 2021.  It’s possible the rule is in real danger of being eliminated as a “pay for” to cover deficit expenses and new legislative initiatives. That would be a huge mistake. No matter what happens in the election, a Section 1031 coalition of likeminded professionals and related organizations who have historically saved the 1031 exchange from the chopping block over the years will continue to educate and inform our legislators about the critical importance Section 1031 plays in our economy.

Knowledge Is Power

The first step in educating people about the need for Section 1031 is making sure that everyone is aware of the two most important Section 1031 studies that identify the microeconomic and macroeconomic benefits. These are the well-regarded 2015 Ling and Petrova study (Ling-Petrova Studies Summaries) , as well as the 2015 Ernst & Young Study (Synopsis of EY Study) which give empirical evidence why Section 1031 continues to be so vital for a strong, vibrant U.S. economy. 

Bottom line, these studies show that the elimination of Section 1031 would be like throwing a wrench in the gears of an engine that has already been backfiring from the economic impacts of COVID-19. Our commercial real estate engine, already under stress, will seize up.  

However, even if COVID-19 was not an issue, the long-term impacts of eliminating Section 1031 would be devastating to our economy. Property owners will sit on their properties to avoid paying new, higher capital gains taxes at the time of the sale. Local and state governments would receive reduced tax revenues related to a slowdown in real estate transactions based on the lack of property transfer taxes, and potentially reduced real estate taxes, because many tax assessors use the sale price of real estate to determine the property’s assessed valuation for tax purposes. 

In addition, income tax revenues would fall as the myriad of professionals involved in real estate transactions would be idled, thus reducing their income that would be taxed. Construction and remodeling related expenditures, as well as the jobs to the different trade organizations would plummet. Eventually communities will become more blighted as their commercial real estate stock, the strip malls, apartments, and rental homes fall into disrepair because the owners would not sell and wouldn’t necessarily have an incentive to improve their real estate.  

When a Section 1031 Exchange transaction takes place, an entire chain of redevelopment and property management often takes place impacting countless jobs such as the appraiser, banker, attorney, title company, carpet salesperson, manufacturer, building security provider, building material supplier, hardware store, painter, roofer, electrician, plumber, moving company, locksmith, and interior furnishing company.

It is our job as commercial real estate professionals to reach out to as many members of Congress as possible. We must educate and explain why so many of their predecessors eventually came to the realization that Section 1031 is too important of an economic engine, particularly in terms of supporting jobs – especially trade labor jobs in the commercial real estate industry. 

This is not a question of politics or party.  Rather, this is a question of sound, common sense policy, and we need to speak up now for a vital part of our tax code that has been an anchor to our economy and a job creator for the last 100 years.  

Daniel Wagner is the senior vice president of government affairs for Inland