Among the changes proposed in the Republican Tax Reform, one that will be of particular interest to those who invest in real estate is the elimination of the 1031 exchange. The tax reform plan, titled “A Better Way,” does not expressly repeal Section 1031, but it also does not preserve it.
The entire purpose of the 1031 exchange is to encourage real estate investment. With the 1031, investors can defer the taxes on money earned from property sales, as long as they use that money to immediately buy a new piece of property.
The Republican Party’s proposal is not the first to suggest eliminating the 1031 exchange. Congress’ Joint Committee on Taxation suggested eliminating it in 2014, estimating that its repeal would result in a forty billion dollar tax gain. President Obama later suggested capping tax deferral at one million dollars, and removing certain types of property, including artwork and collectibles, from those items eligible for a 1031 exchange.
Many people are wondering what will replace this exchange. There aren’t any exact matches in the current tax plan, although other changes may save some real estate investors money. For example, investors are able to put new businesses and investment assets down as expenses right away. This applies to buildings, although it does not include land.
However, these changes may discourage investors from the real estate market, or at least encourage them to hold onto property longer. Timing becomes increasingly important to these investors, both to reduce the amount they will have to pay in taxes, and to ensure that the property has had the greatest possible increase in value. The concern is that, otherwise, any increase in value the property saw while under ownership might be lost to taxes. Not surprisingly then, the reform has been met with opposition from real estate, agricultural, and equipment organizations, who are currently at work looking for alternatives.
Even if you do not invest in real estate or heavy machinery, the 1031 reform will still mark a major change. While amendments to taxes are made frequently, actual reforms of the tax code are much less frequent. The most recent one was in 1986, under Ronald Reagan’s presidency, during which the ability to take passive tax losses was repealed. Section 1031 is bigger, effecting at least 45 percent of real estate transactions, as well as sales of cars, boats, planes, heavy equipment (including mining equipment and farm machinery), art and collectibles, and trade-in business assets.