What's the future of 1031 exchanges?

There is still talk coming out of Washington, DC, concerning tax reform of some type that might yet happen during the two and a half years Obama has left in his term. Certainly the landscape has changed now that the Republicans control both the House and the Senate, and yet the talk continues. It seems unlikely at this point that Congress and the White House would ever agree on any type of individual tax reform; however there seems to be some middle ground for reforms involving entities (corporations, partnerships, trusts, etc.).

Congress is going to push for reductions in the taxation of entities – most likely a reduction in tax rates because Congress believes reducing rates encourages the economy and puts people to work. The White House believes that reducing rates on entities just makes the upper classeven wealthier. These are broad generalizations, but the common ground lies in how you pay for the rate cuts – if you cut one tax by a certain amount, you have to raise another tax an equal amount if you want to keep the budget balanced. The White House would like to find ways to level the playing field between the middle class and the upper class through strategic rate increases and the closing of tax loop holes if there is tax reform in the next year or so.

And “loop holes” is where 1031 exchanges come in – the White House and, quite frankly, some in Congress are of the opinion that 1031 exchanges are little used by the middle class – that exchanges are a tax dodge for the upper class. As a result, they believe that they can pay for some of the rate cuts by doing away with Section 1031 since they only benefit the very wealthy. 

The 2013 Senate Finance Committee issued a Tax Reform Discussion Draft that discussed proposals that ranged from limiting the scope of 1031 exchanges to the outright repeal of the entire code section. The leadership of that committee has changed, but that discussion draft is still out there.

The House Ways and Means Committee proposed a total repeal of Section 1031 in 2014, but again the leadership of that committee has changed. The White House, in its 2016 budget, would limit 1031 exchanges to $1 million per taxpayer per year (which presumably would push the benefit of a 1031 exchange down to the middle class).

I expect that when Congress comes back in the fall after summer recess, tax reform will be a serious topic and it’s naive to believe that exchanges won’t be part of the discussion. Unfortunately, Congress has made several erroneous assumptions about exchanges that have put them in the cross hairs: First, they assume that curtailing exchanges will result in large tax payments. We know from our discussions with taxpayers that they would not likely sell their property if they had to pay a large tax bill. The Government Accounting Office has done a number of studies over the years that bear this out, yet many in Congress don’t believe this is true.

Second, they persist in their belief that only the upper income taxpayer’s avail themselves of exchanges. And while we do handle the exchanges of many large properties, our typical, run of the mill, everyday exchange, is a rental house in the roughly $150,000 price range. We handle 10 of those for every $1 million or larger property we handle.

By far the best approach is to pick up the phone and call your representative...

Third, the Government’s assumptions about how many exchanges happen, and how many tax dollars are not paid as a result, are wildly overstated. The amount of revenue they think they will collect if exchanges are abolished (and assuming that everyone will continue to sell their investment real estate) are dramatically greater than what our research indicates was happening even at the top of the market in 2006 and 2007.

So, assuming that you care (if you’ve gotten this far in this article, I assume you do) and would like to see Section 1031 remain a part of the tax code and an important part of your investment planning techniques, what can you do? Well, what you don’t want to do is a send form letter to your Congressional representatives. The mail is opened by their aides and they’re experienced pros at spotting a form letter campaign – even when the letters are on different letterheads. I doubt that this information goes any further than the nearest round file.

Slightly better are letters you write and send yourself. Depending upon how well you write and are able to make your position understood, as well as how familiar the aide is with your topic, your letter and your concern may or may not be brought to their bosses attention. At best it might be noted, and may go in a file on that particular topic rather than the nearest round file.

By far the best approach is to pick up the phone and call your Congressional representative. You’re going to talk to an aide, but this will be a one on one conversation. The aide will take notes and will ask questions to make sure they understand – so that they can explain your concern to their boss. You and your concern will be noticed.

They say that if you don’t vote, you can’t complain about the outcome. So too – if you don’t let your opinion be known you have no room to complain about your taxes.