So far, 2021 has been full of changes. Some have been welcomed, as we’ve begun to see an end to many pandemic restrictions that kept our country halted for over a year, while other changes could impact us for years to come. Currently, there is proposed legislation that could dramatically limit 1031 exchange transactions, or like-kind exchanges. The legislation, as originally outlined, institutes a tax deferral cap of $500,000 on like-kind exchanges, which could have a significant impact on investors if passed. In the coming weeks and months, we expect this issue to be heavily debated, and it’s possible the future of 1031 exchanges could be unclear for some time.
Since it was first introduced in the 1920s, corporate and individual real estate investors have made use of Section 1031 of the U.S. tax code. It allows investors to defer taxes on capital gains by exchanging the sale proceeds and retired debt of real property into like-kind assets. Businesses that make use of 1031 exchanges span from hospitality and leisure companies to natural resources and mining companies, with many industries in between. The use of 1031 exchanges spans across our entire nation into many industries and impacts millions of individuals, directly and indirectly.
"There is proposed legislation that could dramatically limit 1031 exchange transactions, or like-kind exchanges"
According to a May 2021 report published by Ernst & Young, 1031 exchanges are estimated to support more than 568,000 jobs, providing approximately $27.5 billion in labor income and are expected to generate $55.3 billion in overall value to the U.S. economy in 2021 alone. Because of 1031 exchanges, small businesses that would otherwise not be able to afford expanding to a larger facility, for example, are able to grow their businesses and create jobs. Additionally, many 1031 exchange transactions involve generational properties which would not trade hands if it weren’t for the tremendous incentives and benefits offered by 1031 exchanges. Without this incentive, the market would likely become far more stagnant with fewer assets changing hands.
Although this is hardly the first time 1031 exchanges have been threatened, there is perhaps more cause for concern in today’s climate, as the current political alignment in Washington makes it easier to get bills passed. However, leaders on both sides of the aisle understand the benefits provided by 1031 exchanges, and that dynamic will undoubtedly influence the final outcome.
The bill, as it was originally proposed, is not specific about how changes to 1031 exchanges will be implemented if it does pass. Modifications to that section of the legislation, as well as the bill as a whole, are likely to occur prior to it being voted on. During this time of uncertainty, investors and real estate professionals alike are voicing their concerns and urging leaders to understand the importance of 1031 exchange transactions to the U.S. economy.
"Although this is hardly the first time 1031 exchanges have been threatened, there is perhaps more cause for concern in today’s climate, as the current political alignment in Washington makes it easier to get bills passed. "
Until more is known, investors are encouraged to stay the course. Long-term investing goals should not be abandoned, but investors must also be aware of outstanding opportunities available in today’s marketplace. While tax deferral benefits provided by 1031 exchanges are an excellent motivator for many investors, we shouldn’t lose sight of all the other benefits that come with real estate investing.