Tax season may still be months away, but for many Americans, a proposal to change a section of the tax code is keeping them up at night. The Biden administration is proposing to dramatically limit Section 1031 like-kind exchanges, used by all types of property owners – big and small – to improve properties and further invest in their communities. At a time when many businesses are still recovering from financial hardship felt during the pandemic, the proposed changes would substantially hurt the progress we have made to rebuild our economy.
In April, the Biden administration unveiled the American Families Plan – a $1.8 trillion spending plan that outlined the administration’s key initiatives and how it would fund them. Among the many potential funding methods, the administration proposed placing a cap on the annual capital gains tax deferral afforded by Section 1031 like-kind exchanges.
For the last 100 years, Section 1031 like-kind exchanges have allowed property owners to defer capital gains taxes on the sale of a property when the proceeds from the transaction are used to finance another property. The government still collects these taxes, but only after the new property is eventually sold.
In many cases, these exchanges provide a ladder of economic opportunity. They encourage businesses to take the proceeds from a sale and reinvest them in another property, oftentimes improving existing housing or investing in new commercial and multifamily projects that build and strengthen communities. If the American Families Plan was designed to create an “investment in our kids, our families, and our economic future,” why would it remove a tool that many Americans use to invest in their future?
Roughly 40 percent of like-kind exchanges involve rental housing, offering a critical tool for the expansion of affordable and workforce housing. If capital gains taxes were no longer fully deferrable, one study found that property owners would have no choice but to raise rent significantly.
At a time when so many cities are being reimagined to adapt to the challenges of the past year and a half, we need Section 1031 to develop more affordable rental housing and repurpose and renovate offices, retail space, and hotels. Without these exchanges, many of the properties could languish, with few owners willing to transform the spaces to meet today’s needs.
These exchanges are also commonly used by individual landowners, small businesses, farmers, and even conservation groups seeking to protect wildlife and natural resources. Land conservation deals can exchange environmentally sensitive tracts for less sensitive areas, or the offer of conservation easements. A landowner choosing to sell a permanent conservation easement can utilize a 1031 like-kind exchange to acquire replacement properties.
According to a recent study by Ernst and Young, Section 1031 like-kind exchanges will support 568,000 jobs in 2021. From title agents to construction workers, plumbers to small business employees, Section 1031 like-kind exchanges are a major tool for job creation, adding $55.3 billion of value to the U.S. gross domestic product.
Like-kind exchanges also pay for themselves – and more. The same Ernst and Young study found that Section 1031 like-kind exchanges will generate approximately $7.8 billion in federal, state, and local taxes this year.
The ball is now in Congress’s court – and we urge Congress to preserve the current capital gain tax treatment of Section 1031 exchanges. More than just a tax provision, Section 1031 like-kind exchanges are often the first step toward financial stability for landowners and small businesses. Any changes to these exchanges, particularly as our economy begins to bounce back, would have major consequences for our economic outlook, middle-class Americans, and future generations.
Diane Tomb is the CEO of the American Land Title Association. Bob Broeksmit, CMB is the President and CEO of the Mortgage Bankers Association.