If you are an avid commercial real estate investor, you are probably aware, IRC Section 1031 has been considered for repeal for the past few years. Whenever you sell a business or investment property and you have a gain, you generally have to pay tax on the gain at the time of the sale. IRC section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. “Defer until you die, then let your heirs get the stepped up cost basis“, has been the motto of legions of authoritative investors for generations.
IRC 1031 has played a crucial role in creating a fluid and fast-paced marketplace, as it has given many principals the opportunity to exchange properties, where previously, financial considerations would have prevented it. Sellers working feverishly to postpone the pain of paying tax on years of gains, have been a major contributor to market momentum in our asset class, often small apartment buildings. Exchanging is an engrained part of our eco system and critical to the success of small mom and pop apartment building owners in the San Francisco Bay Area.
The case can be made that many areas (in the bay area specifically, as well as other locations) that the flexibility offered by IRC 1031 facilitated development and growth in areas that otherwise would have been completely overlooked by investors. Jonathan Farrell, a CPA specializing in real estate at DiCucco, Gulman & Co. writes,
“Proponents of the repeal argue that it would help provide extra tax money for governments to invest in commercial development but it wouldn’t make up for the economic losses from lack of transactions and reinvestment. Investors and property owners facing immediate taxes on the sale of assets, likely won’t move forward with a sale that is desired to expand and grow a business but not necessarily needed. Like kind exchanges encourage the development of real estate and keep dollars moving in the U.S. economy.” Repeal of 1031 could wipe out entire sub-markets we count on for our livelihood.
As is true for many smaller investors and property owners, the balance of capital vs. the risk in investment is absolutely crucial, and the flexibility provided by this has allowed them to invest and spur growth in many underserved markets. If IRC 1031 is repealed, the tax burden would hinder many real estate brokerages, and well as completely hamstring swaths of smaller investors. Many have been defending the exchanges: the Federation of Exchange Accommodators has been lobbying Congress and arguing strongly in defense of IRC 1031.
It is crucially important to protect this provision, as it makes the marketplace more flexible and dynamic, and because it is directly responsible for the revitalization of many neglected areas, and in some ways, the prosperity of a city. This is one of the few political issues we should agree upon and work collectively to protect. Democrat or republican, first time investor or institutional powerhouse, this deserves our attention!