Would it be good for the economy to eliminate 1031 tax-deferred exchanges?

Section 1031 of the Internal Revenue Code, allows taxpayers to defer, but not eliminate, payment of capital gains and recapture tax on the sale of investment property. It has been in the federal tax code for the past 100 years but presidential candidate Joe Biden is proposing to eliminate this tax law to save money.

There were discussions about eliminating this tax provision when the Tax Cuts and Jobs Act of 2017 was passed. However, when elected officials were presented with two separate impact studies by Ling and Petrova and Ernst and Young, LLP they decided to retain the law.

Here are some of the key findings from the Ling and Petrova study:

FINDING #1: Like-kind exchanges encourage investment. On average, taxpayers using a like-kind exchange acquire replacement property that’s approximately 33 percent more valuable than the relinquished property. 

FINDING #2: Like-kind exchanges provide only temporary tax deferral. The overwhelming majority (88 percent) of real estate replacement properties acquired through a like-kind exchange are disposed through taxable sales, not subsequent like-kind exchanges.

FINDING #3: It leads to job creation. Real estate acquired through a like-kind exchange is associated with greater investment in capital expenditures (i.e., job-creating property upgrades and improvements) than real estate acquired without the use of like-kind exchanges. 

Here are some key findings from the Ernst & Young study:

FINDING #1: Repeal of Section 1031 would subject businesses to a higher tax burden on their transactions, resulting in a longer holding periods (the “lock-in” effect). 

FINDING #2: Repealing 1031 rules would slow economic growth, shrink investment and ultimately reduce gross domestic product.

FINDING #3: The study concludes that repeal of the 1031 would adversely impact the U.S. economy by discouraging investment, causing a reduction in GDP and a contraction in the economy, and would unfairly burden certain industries and taxpayers.  

You can see that there are tremendous benefits to keeping IRS Code Section 1031 and very few advantages to eliminating it.

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