Since 1924, Congress has recognized that gain should not be taxed when property held for trade or business use or for investment is exchanged for "like-kind" property (property that is similar in value). Section 1031 of the Internal Revenue Code embodies this principle, recognizing that taxpayers exchanging like-kind property have not altered either the type or level of their investment and that the economic situation of the taxpayer has not changed. The ability to defer gain on like-kind exchanges facilitates well-functioning, efficient and dynamic real estate markets, and like-kind exchanges often provide the necessary liquidity to make deals work. They have become an essential component of modern real estate markets.
In commercial real estate, the ability to defer taxes is particularly important because assets are long-lived and past depreciation deductions greatly increase the tax burden of transferring ownership, creating a “lock-in” effect on real estate. In other words, without the flexibility provided by Section 1031, owners of properties needing capital investment face disincentives to selling or transferring that property because of the tax implications. As a consequence, without Section 1031 a substantial reduction in commercial real estate activity would result.
Some have advocated eliminating or limiting the availability of tax deferral for like-kind property exchanges. In the 113th Congress, both Senate and House tax-writing committee chairmen put forth tax reform proposals that would have eliminated or severely restricted Section 1031. The Obama Administration also proposed limiting the availability of Section 1031. In June 2015, NAIOP and a number of other real estate industry associations released an economic study analyzing the use of Section 1031 in commercial real estate and its economic impact, providing much-needed information for policymakers.
The continued use of Section 1031 like-kind exchanges in the real estate industry will be an important part of the discussions on reforming our tax code.
NAIOP opposes eliminating or altering tax provisions allowing for the use of like-kind property exchanges under the current tax system. Eliminating or restricting the use of like-kind exchanges would threaten the liquidity of real estate markets, and would severely curtail transactions and the efficiency of the market. Eliminating tax deferred on real estate exchanges would also create disincentives for owners to transfer properties with past depreciation deductions, and to new investment in distressed properties.