1031 Tax Deferred Exchanges at Risk

NEW YORK CITY—There is very little that the Congressional Republicans and President Obama agree upon, but the elimination of Section 1031of the Internal Revenue Code, the Tax Deferred Exchange provision, would appear to be at risk in both the Tax Reform Proposal put forward by Republican House Ways and Means Committee Chair David Camp, and President Obama’s Proposed Tax Reform legislation. The loss of the ability to do a Tax Deferred Exchange would have a dramatic and significant change in the way in which real estate is held, transferred and taxed. Since both Congress and the President seem to have 1031′s in their sights, the real estate industry should take note and act while it can.

Section 1031 provides that there is no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the taxpayer exchanges the property for “like kind” property. As a result of such an exchange, the taxpayer retains his basis in the original property and the tax on the property is deferred until the new property is sold and the taxpayer pays taxes based on the taxpayer’s basis in the original property. The rationale underlying the 1031 Exchange is that when a property owner is essentially  reinvesting the value of the original property in another similar property, the taxpayer has not had an economic gain so he or she should not be taxed (i.e., the taxpayer’s investment is still in real estate. This section of the Code is especially crucial for the owners of real estate, because their holdings are illiquid and frequently have to be retained for years before there is appreciation in the value of the asset. The elimination of section 1031 would reduce the number of real estate transactions.