Proponents Say 1031 Exchanges Are Good For The Economy,
But Congress Eyes Repeal
A popular tax-deferral strategy for people who deal in investment property could be in trouble as Congress ponders doing away with it.
But already rescue efforts, such as letter-writing and lobbying campaigns, are afoot to counter any talk of repealing Section 1031 of the Internal Revenue Code, which lets taxpayers defer their capital-gains tax on the sale of the property if they reinvest their proceeds in “like-kind” property.
“A lot of people want to make sure Section 1031 exchanges stay in place because doing away with or altering this section of the tax code could be detrimental to investors, the real estate market and the economy,” says Dwight Kay, founder and CEO of Kay Properties and Investments (www.kpi1031.com).
His California and New York-based company specializes in helping clients purchase Delaware Statutory Trust properties (DSTs) using the Section 1031 Tax Deferred Exchange. “It’s a strategy that’s becoming increasingly popular,” says Kay, whose firm is licensed to do business in all 50 states. “But it’s also something that they have their eyes on in Washington, and it’s on the chopping block with Congress.”
The average American probably knows little or nothing about Section 1031, but it’s a significant tax-planning tool for investors who want to sell investment property, but don’t want to get hit with the capital-gains tax that would result.
How Section 1031 exchanges work
Taxpayers can defer their capital-gains tax on the sale of investment property if they reinvest the proceeds from the sale in other investment property.
There are strict deadlines and other specifications that must be met. Several types of property qualify as “like-kind” under the rules. Examples include: apartment buildings, farmland, office buildings, warehouses and rental homes.
Delaware Statutory Trust properties also fall on the list. Delaware Statutory Trust properties are pre-packaged as 1031 exchange properties, so an investor can close a sale quickly with no worry about missing those deadlines.
The idea of repealing Section 1031 has been talked about before. Critics of 1031 property exchanges say they allow people to defer paying capital-gains taxes for decades. Critics also say the definition of “like-kind” property is imprecise, leading to controversy with the Internal Revenue Service and providing significant opportunities for abuse.
The congressional Joint Committee on Taxation projects repealing Section 1031 would increase revenues $40.9 billion over 10 years. Kay, though, suggests there are at least three reasons why keeping Section 1031 in place is good not just for investors, but for the overall economy as well.
- Like-kind exchanges benefit millions of American investors and businesses every year by encouraging businesses to expand and by moving dollars within the U.S. economy. “These property exchanges give a boost to the economy, and can create jobs,” Kay says. Without the tax deferral benefit, reinvestment by small and medium-sized businesses and investors would be inhibited. The economy could suffer as a result.
- Repeal could cause a decline in real estate values because investors would no longer have the ability to defer their capital gain taxes, one of the reasons many invest in real estate to begin with, and therefore may switch strategies and move to more liquid alternatives.
- “Although big-money investors certainly make good use of the 1031 exchanges, this is not something that helps just the wealthiest Americans,” Kay says. It is available to and used by taxpayers of all sizes. “We have helped clients with 1031 exchanges as small as $50,000,” Kay added.
Investors should keep in mind that real estate and Delaware Statutory Trust (DST) properties may include risks such as, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity.
About Dwight Kay
Mr. Kay, founder and CEO of Kay Properties and Investments, LLC (KPI) (www.kpi1031.com), is a Series 7, 22 and 63 licensed, Registered Representative and Real Estate Professional. His firm, Kay Properties and Investments, specializes in Delaware Statutory Trust (DST) brokerage and advisory services. Kay Properties and Investments currently has offices in Los Angeles as well as in New York City and offers securities through Concorde Investment Services, LLC, member FINRA/SIPC, in which KPI is independent from.