“Let me talk to you about the 1031,” I said to a congressional staffer in Washington, D.C. This was during the early days of negotiations on the Tax Cuts and Jobs Act of 2017. The staffer looked at me and blinked. There was a pause. “Ten-thirty-one,” he repeated, somewhat confused. He looked at his wristwatch. Shook his head. “No, it is much later than that.”
The comical back and forth conversation is indicative of why we must constantly educate members of Congress and their staffs about why the Internal Revenue Code Section 1031 like-kind-exchanges, has been a part of our tax code for the past 100 years. Section 1031 allows taxpayers to defer capital gains payment and recapture taxes on the sale of property by reinvesting the proceeds in another property of equal or greater value. Not only are many unfamiliar with the section, but many of those who have heard of it are confused about how it works and how important it is for creating jobs and generating tax revenue for the country.
Section 1031 like-kind-exchanges may be the focus of intense debate in 2021. It will be more critical than ever to get out and educate everyone on Capitol Hill about section 1031. Section 1031 is in real danger of being eliminated as a “pay for” to cover deficit expenses and new legislative initiatives. That would be a huge mistake as explained below. No matter what happens in the election, a section 1031 coalition of likeminded professionals and related organizations who have historically saved the 1031 exchange from the chopping block over the years will continue to educate and inform our legislators about the critical importance section 1031 plays in our economy. It is more critical than ever to get out and start educating everyone on the Hill about section 1031.
Knowledge is power. The first step in educating people about the need for section 1031 is making sure that everyone is aware of the two most important section 1031 studies that identify the microeconomic and macroeconomic benefits. These are the well-regarded 2015 Ling and Petrova study and the 2015 Ernst & Young study that give empirical evidence why section 1031 continues to be so vital for a strong, vibrant U.S. economy.
Bottom line, these studies show that the elimination of section 1031 would be like throwing a wrench in the gears of an engine that has already been backfiring from the economic impacts of COVID-19. Our commercial real estate engine, already under stress, will seize up. However, even if COVID-19 was not an issue, the long-term impacts of eliminating section 1031 would be devastating to our economy. Property owners will sit on their properties to avoid paying new, higher capital gains taxes at the time of the sale. Local and state governments would receive reduced tax revenues related to a slowdown in real estate transactions based on the lack of property transfer taxes and potentially reduced real estate taxes because many tax assessors use the sales price of real estate to determine the property’s assessed valuation for tax purposes. In addition, income tax revenues would fall as the myriad professionals involved in real estate transactions would be idled, thus reducing their taxable income. Construction and remodeling related expenditures as well as the jobs belonging to trade organizations would plummet. Eventually, communities will become more blighted as their commercial real estate stock — the strip malls, apartments and rental homes — fall into disrepair because the owners won’t sell and wouldn’t necessarily have an incentive to improve their real estate.
When a section 1031 exchange takes place, an entire chain of redevelopment and property management often takes place, activating countless jobs such as the appraiser, banker, attorney, title company, carpet salesperson, manufacturer, building security provider, building material supplier, hardware store, painter, roofer, electrician, plumber, moving company, locksmith and interior furnishings company. Real estate activity gets locked in by higher tax-rates without the availability of tax deferral through the section 1031, so none of the previously mentioned benefits would happen.
It is our job as commercial real estate professionals to reach out to as many members of Congress as possible, especially Democrats who currently control the House Ways & Means Committee and who may support presidential candidate Joe Biden’s campaign proposal to eliminate section 1031. We must educate and explain why so many of their predecessors thought they could use the elimination of section 1031 to pay for programs, only to withdraw those plans after being educated and coming to the realization that 1031 is too important of an economic engine to take offline. This is particularly for supporting jobs — especially trade labor jobs in the commercial real estate industry. This is not a question of politics or party. Rather, this is a question of sound, commonsense policy, and we need to speak up now for a vital part of our tax code that has been an anchor to our economy and a job creator for the past 100 years.
Dan Wagner is senior vice president of government relations at The Inland Real Estate Group of Cos.