Washington Has Launched Attack on Section 1031 Tax-Deferred Exchange Transactions

Posted on in Commercial Real Estate, Tax

In case you have not heard or read, tax-related services and companies have been prolific in writing about proposed changes to rules and regulations that will eliminate or severely impede Section 1031 tax-deferred transactions. Investment Property Exchange Services, Inc. Vice President, Claudia Kiernan, reported in April that, although 1031 Exchanges have been used since 1921, recently Section 1031 Exchanges have been under fire by the House, the Senate, and the President. Each has proposed to limit or terminate application of Section 1031 of the Internal Revenue Code.

Section 3133 of the House Ways and Means Committee's Proposed Tax Reform Act of 2014 repeals Section 1031. On February 25, 2014, Chairman Dave Camp released a Discussion Draft of the proposed Tax Reform Act stating that Section 1031 "like-kind" exchanges should be repealed effective January 1, 2015. A "like-kind" exchange would only be enforceable if it is included in a binding contract entered into before December 31, 2014 and the exchange is completed by January 1, 2017.

The Senate Finance Committee also proposed the repeal of Section 1031. Max Barcus' tax reform Discussion Draft from November 21, 2013 eliminates the section in its entirety. The repeal would be effective beginning January 1, 2015.

President Obama's 2015 Budget released on March 4, 2014 also suggests that 1031 Exchanges should be limited to a maximum deferred amount of $1,000,000.00 per taxpayer per year. The reasoning for the adjustment is to limit the amount of real estate gain that qualifies for deferral while allowing small businesses to continue their current practice of 1031 Exchanges. The Treasury would have authority to implement these changes, which if passed by the House and Senate, would be effective after December 31, 2014.

The general reasons offered by the House, Senate, and President for the proposed elimination or limitation of 1031 Exchanges include a contention that there is no strong justification for 1031 Exchanges. The proposals claim that the traditional justification for 1031 Exchanges, which is that it is difficult to value exchanged properties, is weak since in order to exchange properties the taxpayers must be able to value them. Additionally, it is suggested that ability to exchange unimproved real estate for improved real estate under Section 1031 encourages permanent deferral. Finally, the proposals suggest that since "like-kind" is not precisely defined, it encourages abuse of the deferral opportunity. None of the proposals or recommendations takes into account the stimulus effect that Section 1031 exchange transactions have on the economy, particularly in the arena of commercial real estate.

While many observers generally believe that it is unlikely that anything regarding tax reform will occur in 2014 since it is an election year, these proposals to eliminate Section 1031 exchange transactions, if approved, could result in a sharp decrease in real estate transactions in the future.

The author would like to thank Lauren Maxey, a 3L at University of Richmond Law School, for her assistance with this post.

Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.