The future of 1031 like-kind exchanges - by John Varella

John Varella, Lourie & Cutler

It is presidential campaign season and the candidates are beginning to offer up their proposals for tax reform. Of interest to many real estate owners and developers are the candidates’ proposals on Section 1031 like-kind exchanges. Will any of the candidates propose limitations on, or even the elimination of, the like-kind exchange?

Section 1031 of the Internal Revenue Code provides an exception from gain recognition on the sale of real estate that is held for use in a trade or business or for investment. In general, the exception applies when the seller of the real estate uses the proceeds of the sale to purchase a second piece of real estate for use in a trade or business or for investment. Section 1031 permits the seller to defer the recognition of any gain on the sale of the first property under the theory that the cash proceeds have been reinvested in the second property. Consequently, the gain recognition is deferred until the sale of the second property; unless, of course, the owner once again avails itself of Section 1031 on the sale of the second property, in which case the gain recognition is further deferred.

Section 1031 has proven to be a very valuable tool for real estate owners and developers. It is estimated that in calendar year 2011 alone over $30 billion in gain was deferred by taxpayers. As a result, President Obama has proposed limiting the Section 1031 gain deferral to $1 million per taxpayer per year. The Treasury Department believes this proposal would raise over $20 billion in revenue over a decade. However, the President’s proposal is not as extreme as the proposal of Democrat Max Baucus and Republican David Camp, who have proposed to eliminate the deferral entirely. Complete elimination of the exchange could have dramatic negative effects on the real estate industry.

What will the candidates propose on this issue? Although several candidates, including Hillary Clinton, Jeb Bush, Bernie Sanders, Marco Rubio and Donald Trump have offered up general tax proposals, none of them have specifically addressed the Section 1031 issue just yet. However, as the campaign moves along, watch for Section 1031 to become a significant tax issue.

John Varella is an attorney with Lourie & Cutler, Boston, Mass.