With proposed legislation in the American Families Plan, the 1031 exchange program is in jeopardy, and it WILL affect commercial property owners, business owners and American tax payers.
What is the 1031 exchange? For over 100 years, tax deferred real asset exchanges (currently referred to as an IRS code section 1031 or more simply 1031 Exchanges) have allowed real property owners to exchange their property for other like-kind assets and defer taxes on that exchange. For example, after the owner sells the property, no taxes are due immediately on the capital gains of the property that is being sold.
How does the 1031 exchange benefit business owners? Business growth can stress cash resources of companies, as they add employees, plant and equipment. The purpose of the original legislation for tax deferred exchanges was to allow businesses to expand without adding an additional cash burden. Allowing businesses to grow is a win-win for business, the public and government alike because growing businesses add to the tax base tax, as well as adding jobs which has a multiplier effect on the economy.
Proposed change in 1031: The American Families Plan proposes to limit IRC §1031 to $500,000 in gain, per taxpayer and per tax year. Married couples filing jointly would be limited at $1,000,000 in gain per tax year. Further information is still limited.
Why should I be concerned about this as a business/property owner? The law change will place an additional cash flow burden on any entity wishing to upgrade assets, which in turn will have a dampening effect on future growth.
A 2015 study by Ernst & Young concluded that eliminating or greatly reducing access to Section 1031 exchange rules would:
- Increase capital flight out of US
- Reduce levels of investment in real estate, potentially causing asset price deflation
- Slow economic growth
- Increase cash flow burdens on industries that rely heavily on 1031 Exchanges
- Result in a long-term contraction in the overall US GDP or approximately $8.1 billion annually
In conclusion, capping or eliminating the 1031 will stifle economic growth and create cash flow problems for expanding businesses. Many businesses will not have the money upfront to pay the IRS in order to build out a new facility. By taxing business owners on the front end of an expansion and not the back end of profits earned, economic growth will suffer. We encourage you to contact your congressional representatives and voice your concerns.
