FEA Letter to Senate Finance Committee

Aug 4th, 2017

"IRC §1031 is a powerful economic stimulator that is grounded in sound tax policy. The non-recognition provision is premised on the requirement that the taxpayer demonstrates continuity of investment in qualifying replacement property with no intervening receipt of cash. There is no profit-taking, and at the conclusion of the exchange, the taxpayer is in the same tax position as if the relinquished asset was never sold...

Immediate expensing does not remove the lock-in effect on a host of real estate owners. Given that improvements would be eligible for immediate expensing, but the value allocated to land would not be deductible, it is important to recognize that land values represent approximately 30% of the value of commercial improved properties, and up to 100% of agricultural land investments. If these property owners are faced with reducing the value of their investments and life savings through capital gains tax when they sell and reinvest in other real estate, even with lower rates, they will likely hold onto these properties longer. The ability to use §1031 to defer gain recognition removes the lock-in effect, takes the government out of the decision-making process, and permits taxpayers to engage in opportunistic transactions that make good business and investment sense, and that create jobs, without fear of negative tax ramifications. ..

Like-kind exchanges make the economics work for conservation conveyances of environmentally sensitive lands that benefit our environment, improve water quality, mitigate erosion, preserve wildlife habitats, and create recreational green spaces for all Americans...

Most taxpayers benefitting from like-kind exchanges are not ultra-high net worth individuals or large corporations. These individual taxpayers do not have use for a large net operating loss carryforward from the unused expense deduction for real estate improvements. They do not have sufficient related income to offset the expense, thus they would realize minimal benefit. These taxpayers would face a massive amount of depreciation recapture upon sale, for which they may not have sufficient liquidity, or may not have set aside enough cash to satisfy, creating further personal challenges, locking them in, and putting other wealth building options out of reach. The tax-deferral provisions of Section 1031 fill this gap by permitting full reinvestment of sales proceeds into like-kind property, thus preserving business liquidity and helping firms to create jobs...

The proposal to fully expense real estate improvements in the year of acquisition, with an unlimited carryforward, provides a tremendous incentive at acquisition for a taxpayer to inflate the value of improvements, so as to maximize the write-off. Conversely, upon sale, there would be great incentive to minimize the value of the buildings and over-allocate value to the land, thus minimizing recapture tax on the improvements at ordinary income tax rates, and benefiting from lower capital gains tax rates on the land."

FEA Recommendations for Tax Reform