Like-kind exchanges, which are often referred to by the section of the United States Tax Code known as “1031” have been around forever. However, with current administration’s focus on tax reform, discussions about this code have become more commonplace. The signing into law of The Tax Cuts and Jobs Act on December 22, 2017, much of the tax code has undergone modification including the rules surrounding like-kind exchanges. Given these changes, it’s probably time for a fresh look at section 1031.
Defining Like-kind and Exchange
Properties are of like-kind, if they are of the same type, regardless of value. Two pieces of residential real estate would qualify as like-kind. However, livestock of different sexes would not be considered such. Neither would a car exchanged for a parcel of land. Per the IRS, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031. That’s a big a plus as long as you follow all of the associated rules, like working with a qualified intermediary and adhering to the specific time constraints. Often, finding a replacement property within the first 45 days following the sale of a property is the most challenging component of a like-kind exchange.
What the pundits say about like-kind exchange
While providing tremendous opportunity for the real estate investment community, the idea of like-kind exchanges is not without controversy. In fact, in 2015, in response to legislative proposals to repeal 1031, the Section 1031 Like-Kind Exchange Coalition commissioned Ernst & Young to conduct a study on the economic impact of like-kind exchange. In its study, the firm concluded, “…that repealing like-kind exchange rules would slow economic growth, reduce GDP and hurt many U.S. small businesses.” Other studies conducted by Syracuse University and the University of Florida also concluded that 1031 was key to stabilizing rents and safeguarding property values as well as strengthening the economy.
This portion of the tax code is an important one, and the National Association of Realtors has thrown their full support into ensuring that the deferment of capital gains taxes through reinvestment of sale proceeds on assets held for business and investment purposes continues. The association emphasizes their position by noting that 63% of realtors rely on 1031 exchanges rely on the tax provision to make deals happen
Tax Cuts and Jobs Act of 2017
Tax reform has been the darling of politicians since the mid-eighties when the last significant change to the country’s tax code was enacted under President Reagan. Since then, numerous proposals have looked to change or repeal Section 1031, though none have ever passed. So, the changes to Section 1031 makes the 2017 Tax Cuts and Job Act a noteworthy piece of legislation, the full implications of which will take some time to digest and understand fully.
It’s important to note that despite some changes to the Section 1031, many of the codes key tenets have remained unchanged. Real estate that’s improved or unimproved remains like-kind to all other real estate in the United States. Foreign real estate cannot be like-kind to real estate in the U.S. As always, a qualified intermediary must facilitate the exchange and the 45-day identification and 180 day exchange periods are both still in force.
It will be important to continue to monitor legislation surrounding Section 1031. Changes in the balance of power in Congress could introduce additional risk to the stability of the code as evidenced during the Obama administration. Since the 2017 Tax Reform and Jobs Act was not revenue neutral, 1031 may become easy pickings as Congress looks for pay-fors to offset the additional $1.5 trillion increase to the deficit over the next ten year. Additionally, there could be attempts to “clean up” the code which was quickly passed in the waning hours of 2017 to fulfill on the President’s commitments. For now, however, be sure to consult your real estate and tax professionals for the most up-to-date information regarding 1031, before you make your next investment.