Congress is again discussing implementing significant changes to or eliminating the 1031 exchange rule in efforts to reform the tax code.
The 1031 section of the IRS tax code (also known as a Starker Exchange) allows for the exchange of certain types of property deferring the recognition of capital gains or losses due upon sale, thus deferring any capital gains taxes otherwise due.
Washington’s attempt to simplify this portion of the tax code is shortsighted. Congress enacted the like-exchange statue in 1921 for three reasons: first to encourage active reinvestment, second to avoid unfair taxation of ongoing investments in property and finally for administrative convenience. The last ceased to be relevant to the underlying policy within several years after its passage.
Like exchanges have become not just important but an essential component in today’s commercial real estate markets often providing the needed liquidity to complete the transaction. Any changes to the code would have a devastating effect on the real estate market resulting in the substantial reduction of transactions and lack of desirability by investors to “actively reinvest” – a factor more relevant than ever in today’s global economy. Without active reinvestment and the incentives offered by the 1031 code – property and community development along with the resultant job growth as well as the overall benefit to the economy would come to an immediate halt.