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A Section 1031 like-kind exchange is a transaction where a business or investor exchanges one property—real or personal—for another of like kind. The business or investor is able to defer taxes on any gain on the exchanged property until the replacement property is ultimately sold. The provision can be used in transactions with all types and sizes of real estate, including office buildings, farmland, warehouses, and undeveloped land, and is utilized by both commercial and residential real estate professionals.

Like-kind exchanges encourage property owners and businesses to sell when they otherwise would not be able to do so because of the tax implications. This allows development to move forward and encourages the efficient use of property. Like-kind exchanges help small businesses build equity and reduce the need for third-party financing, helping them to grow organically without over-reliance on debt and leverage. Businesses can reinvest capital without reduction from taxes, which puts more capital back into productive use. As a result, like-kind exchanges have proven to be important drivers of the U.S. economy, boosting job creation. Without the 1031 framework, many properties would languish or remain underutilized because of the tax burden that would apply to an outright sale.

These statements are not just talking points—they have their basis in sound research. A recent academic study that analyzed nearly two decades of like-kind exchanges found that like-kind exchanges lead to greater capital expenditures, investment, and tax revenue while reducing the use of leverage and improving market liquidity. Another study concluded that new restrictions on the 1031 framework—limiting its use or repealing it altogether—would increase the cost of capital, discourage entrepreneurship and risk-taking, and slow the rate of investment.

Both the Trump White House and the Republican-controlled Congress have tax reform near the top of their agendas. Recent tax reform proposals have included provisions limiting or repealing Section 1031. In June 2016, House Republicans released their “blueprint” for tax reform, which outlined a bold and detailed proposal. Though it does not mention like-kind exchanges, it provides for the immediate expensing of commercial buildings, rather than depreciating them over time—a move that some key lawmakers believe is a viable alternative to Section 1031. This is demonstrably untrue, partially because land is excluded from the immediate expensing provision. Also, highly-appreciated real estate sold and then replaced under immediate expensing would fall far short of the current tax benefits from a like-kind exchange.

Section 1031 is in danger largely because it is misunderstood. Since tax reform probably needs to be “revenue neutral” (resulting in no changes to the total amount of money the government receives in taxes), tax writers will need to find offsets to help “pay for” lower tax rates. Thus, provisions like 1031, which may seem to be an unwarranted tax loophole to those unfamiliar with it, are threatened. In reality, if this provision is limited or removed, the impact would be counterproductive to the GOP goal of tax reform—less growth, fewer jobs, and, ultimately, less tax revenue for the federal government.

NAR is committed to ending the confusion about Section 1031 in Congress, advocating for its protection and working with other real estate groups to provide the best information to the tax-writing Committees about the important role it plays in our economy. Retaining Section 1031 was one of the NAR Capitol Hill “talking points” for its May 2017 REALTORS® Legislative Meetings & Trade Expo conference, and NAR will continue its advocacy efforts to ensure this vital section of the tax code remains in place.

Erin Stackley is senior policy representative, Commercial Issues, for the National Association of REALTORS®.

This column is brought to you by the NAR Real Estate Services group.

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