Five Unintended Consequences of Limiting Section 1031 Exchanges
When 1031 exchange code is referred to as “a tax loophole for the uber-wealthy” or is described as impacting “real estate moguls” it seems logical to assume that if $1.4 billion of federal taxes are avoided every year then eliminating this section of tax code will generate much-needed dollars to help fund federal programs.
This type of language is, at minimum, extremely misleading even bordering on disinformation. Section 1031 is an incentive to middle-class Americans and contributes significantly to class mobility. In 85% of exchanges the governments collect the deferred taxes; and in many instances more than they would have without an exchange involved.
If you are reading this newsletter, you likely have a basic understanding of a 1031 exchange. Perhaps you have utilized this strategy to exchange into an investment that suits your current life situation better. We will not elaborate on the details, the limitations, or the structure of this tax section. We will only say that when Section 1031 is utilized the taxpayer does not realizes a single dollar of profit.
Section 1031 exchanges are transactions of choice. If people have to sell, they typically need cash and are not able to take advantage of a 1031 exchange. These people sell their property, collect the cash and pay their taxes. People who do not need the money choose to exchange their real estate only when they can do so without having to be taxed on the transaction. Eliminate Section 1031 and you eliminate these transactions of choice.
The changes to Section 1031 currently being considered will not increase federal revenue. Numerous studies have reached this conclusion.
Congress is currently considering eliminating (or severely limiting) this 100-year-old investment strategy. You can make a difference. Contact your member of Congress and U.S. Senator today. Tell them how you utilized Section 1031. Tell them this is a bad idea. Tell them this mill impact middle America much more severely than Wall Street. To take action, click here.
Here at Millcreek Commercial, we have compiled a list of Five Unintended Consequences of Limiting Section 1031 Exchanges
- Diminished Quality of Rental Housing: A transfer of ownership brings new capital, new vision and increased tax incentives to promote investment into a rental property. New owners almost always upgrade and improve a property. Aging, tired owners allow capital improvements to go undone. They patch and repair instead of replace and improve. When investors are forced to hold onto their residential rentals through their retirement years the housing stock will suffer.
- Suburban Sprawl: The most important tool utilized by home developers to acquire land in the path of growth is Section 1031. A developer cannot force a farmer to sell. They can only entice him. Section 1031 is the carrot that works best. Landowners can trade their farm ground in the path of growth for fertile farmland further away from the population center and continue their way of life – their family culture. Without this carrot, a farmer that does not want to sell because of the tax consequences simply will not sell. Developers will pass over the large parcels to find someone who is ready to sell. This will result in bad suburban planning and significantly contribute to urban sprawl.
- The cost of entry-level housing will increase: Outside of the dense urban areas the suburbs are where quality affordable entry-level housing can be found. The low cost of land is the major contributing factor to this. When landowners are forced to pay increased taxes instead of deferring them until they need to sell, the price of the ground will increase. These increases will be passed through to the first-time homebuyer. Entry-level homebuyers will pay the tax through increased housing costs.
- Decreased Quality of Life for Our Senior Community: The majority of 1031 exchanges occur when investors are into their retirement years. They often choose to exchange their fourplex or small apartment investments into passive commercial triple net leased investments. Without a 1031 exchange as an option, these senior citizens will be forced to sell their property and pay a myriad of taxes thus decreasing their retirement income. Or, in the alternative, remain chained to their residential rentals dealing with the tenants, trash and toilets. Instead of traveling and visiting the grandkids, they will be forced to work through their golden years managing and maintaining their residential rentals.
- A Decrease in Federal Revenue From Other Avenues: Multiple experts and studies assert that the net impact of eliminating, or severely restricting Section 1031 exchanges will cause a net decrease in tax revenue. Section 1031 exchanges are transactions of choice. Consider this, new investors are typically not in an exchange and borrow money to complete the purchase. Borrowed money stimulates the economy. Every transaction has 6% to 10% in transaction costs. These costs are taxed as income to the service providers. When the person invoking Section 1031 exchanges into their replacement property, the seller is often taking his revenue as gain and paying taxes. Without the 1031 exchange buyer choosing to trade his property the new investor would not be stimulating the economy with borrowed money, the service industry facilitating the transactions would not be earning income (and paying taxes) and the seller of the replacement property would not be paying capital gains taxes on his proceeds.
Limiting Section 1031 exchanges will have extensive ripple effects that are not being considered. Please contact your elected officials today and tell them not to alter Section 1031.
Write your congressman here.