Editor's Note: A version of this post on the 1031 like-kind exchange (LKE) appears as an article in the most recent Terra Firma magazine, which is available in e-form here.
Did 1031 Like-Kind Exchanges Dodge a Bullet?
By Evan Liddiard
In the run-up to the 2020 election, alarm bells started ringing in the real estate world when Joe Biden’s campaign suggested that one way to help pay for his massive spending plans, if elected, would be to phase out the like-kind exchange (LKE) for higher-income Americans.
Many progressives have long painted section 1031 as a tax giveaway for real estate moguls with few redeeming qualities for anyone else. Thus, many saw it as a chance to raise revenue to pay for childcare and Medicaid expansion while adding equity to the tax law.
Fast forward to late 2021. Now-President Biden presented his Democratic colleagues in Congress with a scaled-back framework of the “Build Back Better” act that seemed on the verge of passing the House of Representatives and possibly the Senate.
Yet, 1031 long ago fell off the list of the nearly $2 trillion package of tax increases, even though the Biden Administration put it forward as an integral part of the plan this spring. What happened?
The Myth of the Loophole
To answer this question, we need to dig deeper into political perceptions. The fact is, Section 1031 has long been poorly understood by policymakers and, as a result, finds itself on a perennial list of so-called “loopholes” that should be stricken from the law. This is because far too few Members of Congress have a solid understanding of how LKEs work.
Thus, when left-wing groups brand 1031 as “tax free” or “improper,” it is easy for the uninformed to believe this is just one more “freebie” in a tax code tilted toward the rich. Fortunately, proponents of preserving the like-kind exchange had recent experience in defending it against repeal.
A Fight for the Like-Kind Exchange
Four years ago, the provision was in danger from the other side of the aisle. Republicans pushing for tax reform decided that the LKE was not needed in a world of immediate expensing for real estate. Trade groups and others quickly formed a coalition to fight elimination. The result of intense efforts over more than a year was that 1031 was saved for real estate, even though it was lost for personal property.
However, success in 2017 taught defenders of the LKE that there are two keys to its preservation: education and data. The coalition commissioned two economic studies–one from a pair of respected academics and the other from a leading accounting firm. These, together with recent surveys of REALTORS® that showed just how pervasive exchanges are on Main Street America, told a tale far different from the myths about how critical exchanges are to job creation, neighborhood improvement, and economic growth at all levels.
A Coalition Reconnected
When the Biden campaign started the repeal drumroll again in 2020, the coalition quickly regrouped. The studies and surveys were updated, and new members were recruited that could better carry messages that appeal to Democrats, such as how 1031 helps with land conservation and assisting minority business owners in financing expansion.
Altogether, more than three dozen groups participated in an intense crusade to educate Congress. REALTORS® and others in home states and districts of key Members of Congress also weighed in. By the time the White House put forward its proposals, the coalition’s message had reached every key Democrat on Capitol Hill. A critical level of support for limiting 1031 evaporated and the provision dropped out of the bill.
So, does this mean that LKE supporters can now relax? Not at all. We must remain vigilant and ready to continue the education process on the value of Section 1031.
Refresher: What is an LKE?
“Like-kind exchanges, also referred to as 1031 exchanges, have been in the tax code since 1921 and have allowed for taxpayers to exchange property that is similar and defer the recognition of gain. The justification surrounding the deferral of gain is that a taxpayer who enters into the exchange is merely changing their investment vehicle. Based on the mechanics of the provision, the taxpayer's gain that would have been recognized had they sold the property outright is embedded in the property received. In other words, the asset appreciation on the exchange is not eliminated, but merely deferred until a later point in time when the taxpayer eventually sells the property received in the exchange.” ~ Forbes
About the Author:
Evan Liddiard is Director of Federal Tax Policy for the National Association of REALTORS®, based in Washington, DC.
He joined NAR in 2013 after serving for more than 20 years as the Senior Tax Policy Advisor to Senator Orrin G. Hatch (R-Utah), the former chairman of the Senate Finance Committee. He has had tax practice experience with large and small accounting firms before and after working on Capitol Hill. Mr. Liddiard received his undergraduate degree in Accounting from the University of Utah as well as graduate degrees from The George Washington University (Legislative Affairs) and American University (Taxation). He is currently an adjunct professor in the business graduate tax program at American University in Washington, where he teaches a tax policy course as well as a course on the taxation of real estate transactions.