You’re on My List: The 1031 Exchange May Be History

You’re on My List: The 1031 Exchange May Be History

The political rumor mill is hinting that the venerable 1031 exchange, an invaluable tool for real estate operatives, may soon be no more.

Who could object to the 1031? Its pedigree stretches to 1921, though its familiar form dates to 1954, when it got its modern name five years before I managed the trick. It’s an oldie.

A 1031 exchange allows property investors to swap assets without having to pay capital gains taxes – those are deferred. One property investment is transformed into another without tax penalty, the original intent of the law. In older times, the government feared that taxing capital gains in essentially equal exchanges would inhibit productive investment behavior. That was then, I’m afraid.

Simple in conception, the 1031 is blindingly complex in execution with ill-defined rules, tightly controlled timings, necessary intermediaries, hidden costs, shifting definitions, tax implications of dizzying variety and now, political jeopardy.

Yet if you want to swap, say, a block of apartments for a strip mall, not to say a strip club, you can still do it – 1031 lives for now. Real estate investors love the 1031, but it takes expert counsel to execute: this isn’t the time to skimp on costs, or horrors, try to go it alone. Choose quality, and here fortune smiles: a 1031 generally isn’t too expensive to transact, even at wood-paneled advisories.

So let’s talk that jeopardy thing. When I was in London in 1990, the lads would lament the decline of proud British Rail, withered to a paltry vine, its Victorian glory distant as Empire. “Mrs. Thatcher simply doesn’t like trains,” they’d drawl, ersatz Iron Ladies. On post-colonial shores, you might hear it today: Mr. Biden simply doesn’t like tax breaks. Particularly if you’re a big earner.

It’s hard to figure what’s up: the news is filled with untrustworthy reports of complex 1031, the White House’s intent, when it might happen, if at all. Some reports say the administration is aiming to cancel 1031, but only for people earning more than $400,000 per year. That part sounds right: those folks are first on his hit list. I think Mr. Biden simply doesn’t care for them.

Killing the 1031 for the wealthy may be a classic case of a pried-up campaign plank made policy: sounds good, hard to do. Laws and regulations, as a rule, apply equally to all. The 1031 can be exploited by anyone and its practical use is pretty democratic, my real estate guys and gals tell me. What gives?

The 1031 exchange market is worth around $40 billion each year. If the tax break were eliminated for everyone – and I’ve got a prickly feeling this could happen, eventually – that’s the most supporters can expect in new tax revenue.

In a blog post last week, I mentioned that our government spends around $40 billion every 12 hours, the time it takes me to binge-watch the 2013 World Series. The real estate industry is under big pressure from the pandemic. Why upset the apple cart for pitiable gains? Something more than dollars must be at stake.

When candidate Biden proposed eliminating the 1031, he was aiming at President Trump’s soft spot, his real estate wealth and low tax bills. Trump once even bragged, it’s reported, about using 1031 and other legal dodges to avoid capital gains taxes. Biden wanted to embarrass him, so he named names, put 1031 to the wall. President now, Biden may have to act on his words.

A curious thing: Trump is to blame. After all, he showed Joe the way. The Tax Cut and Jobs Act eliminated personal property assets from 1031 like-kind exchanges – no more trading racehorses for you. Section 1031 was gutted, with one exception: real estate. The choicest cut remained. A real estate mogul is a mogul for life, it would seem.

Useless gestures are common in politics. President Clinton’s assault weapons ban forbade the import of rifles with bayonet lugs – the bit that goes ‘click’ when a warrior fixes his pig sticker. America’s streets were not, repeat not, overrun with bayonet crime – I was there in the ‘90s, I’d remember. Yet this do-nothing rule made the ‘banned’ list longer, pleasing supporters and lulling opponents. And so it goes in DC.

I see little reason to kill off 1031, but political semaphoring may require its end. Eliminating tax breaks that favor the wealthy matches the income disparity script so crucial to Democrats. Income disparity is a real problem in my view – I used to berate my betters on investment bank trading floors: “Take the meat, but leave us the bones,” I’d rail. The Fool can be bold.

Pre-election, candidate Biden declared that tax funds raised by slaying 1031 would be spent on children and senior citizens – I defy you to oppose that. Taxes and funding aren’t that clear cut: how do I know they won’t buy some jets or a submarine? Biden’s statement was maybe a sincere declaration of intent: tax the rich and give to the neediest. Or it could have been something else.

Would making the change help the needy or just harm the bold? This is what bugs me.

This recalls my first encounter with ideologically informed authority – 5th grade, Ripley School in Concord, MA. I was bouncing a tennis ball off a brick wall. Ripping fun, yet it violated the Rules. Ball confiscated; my sorry behind, principal’s office. My name went in the naughty book; I was sternly lectured: no tennis balls for you. Freudians, take note of the cruelty. Crafty croc-tears got my ball back, but the heinous bouncing ceased. Chalk one up for the fun killers.

I needed that ball, because I liked to play tennis in the basement at home. That ball could zing, cracking its fuzzy face on the concrete – fully unregulated fun. A bit unaimed, though; the zipping ball finally found the storm windows. I wonder if there’s a formula measuring the penetrative power of tennis balls against a) glass windowpanes, and b) brick walls. My father, Mr. Stern, met my genuflected apology with laughter. Was I having a good time? So who cares about windows?

This leads to my point. What are investors doing when they conduct a 1031 exchange? Dodging taxes or building wealth? Pummeling the societal order or building it up? If I ever ran for office – as if – my platform would state: every tax-increase dollar must be matched by one dollar in spending cuts. Too mad for school, I know it.

We know this today: the 1031 is still available to all investors. This isn’t a field for dilletantes: you’ll need to consult a planning team and find a top-flight exchange facilitator – like I said, no skimping allowed. The 1031 may survive the cut for a while, but in playground speak, there’s no time for dawdling. Time sure does zip and political reality changes in a flash.

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