Real Estate Industry Supports 1031 Exchanges
Though lobbyists and lawyers doubt that both the House and Senate will pass legislation that would eliminate the property swap tax loophole, commercial real estate agents aren’t taking any chances.
The Senate Finance Committee is considering a repeal of Internal Revenue Code section 1031, which allows businesses and investors to exchange property for “like-kind” property of equal or greater value and defer payment of capital gains tax from the sale of the property. Though there are rules to the process, including a 45-day deadline from the time of closing to identify the like-kind property and 180 days to exchange the property, proponents say the repeal would close a loophole that’s long been used by wealthy investors to avoid paying taxes.
Local commercial real estate agents disagree. They say like-kind exchanges stimulate the economy.
Chris Zarpas, a vice president of S.L. Nusbaum Realty Co., said he and the company made $500,000 in gross commissions in the last 2 1/2 years from just two 1031 exchanges and he’s not the only one on staff closing these types of transactions.
1031 exchanges, said S.L. Nusbaum agent Bill Overman, allow an investor to use the money that would have been paid in taxes to buy more property.
“Without it,” he said, “sellers would be far more reluctant to sell their properties.”
According to the Tax Reform Act of 2014 drafted by the House Committee on Ways and Means, chaired by Congressman Dave Camp, R-Michigan, the Joint Committee on Taxation estimates revenues would increase by $40.9 billion from 2014 to 2023 if like-kind exchanges were repealed.
In his federal 2015 budget, President Barack Obama has proposed limiting the amount of capital gain deferred under section 1031 from the exchange of real property to $1 million per taxpayer per taxable year.
If the budget passes as is, the provision would be effective for like-kind exchanges completed after Dec. 31.
Liz Atkinson, senior counsel with Norfolk firm LeClairRyan, said there are ways around the cap.
“You might see properties being broken into $1 million slices,” she said. “Anytime they create something, we tax lawyers stay up late thinking of some way around it.”
Atkinson said IRC section 1031 is an old provision, put in place for farmers back in the 1920s.
“Originally it was a land swap,” she said. “If you swapped farm land for farm land, the IRS said no cash is changing hands, so we’re not going to tax that. We’re only going to tax that land when you sell it. Intuitively it made sense.”
It was the case Starker v. United States, she said, that allowed deferred exchanges, which applied to property held for investment and personal property.
“If you were clever, you’d buy rental property, do a deferred exchange and buy more rental property,” Atkinson said. “When you die, you never pay the tax. That’s why this has become an attractive revenue-raiser. It’s something people view as benefiting wealthy people.”
Congress ultimately set limits on the deferrals – 45 days to identify the like-kind property, 180 days to close and a two-year look-back on personal property, meaning you have to have lived there for two years before it can become a rental.
Though industry insiders expect no action to be taken on 1031s this year, tax reform is on its way.
“The issue is next year,” said David Brown, president and owner of IPE 1031, an Iowa-based company that specializes in providing qualified intermediary services for delayed exchange transactions and exchange accommodation titleholder services for reverse and improvement exchange transactions.
“They’ll start tax reform next year,” Brown said. “All these proposals to change the tax code are absolutely live and must be taken seriously. It’s up to the stakeholders including commercial Realtors to talk to their congressman and let them know what an important part 1031 plays in their business.”
Brown estimates that 1031 exchanges are implicated in 30 percent of all transactions proving that the Real Estate Industry Supports 1031 Exchanges.
“If 30 percent of all transactions went away, what would that do for the economy?” he said.
Thank you: Inside Business