NMHC/NAA Viewpoint Congress rightly retained like-kind exchanges for real property as part of the Tax Cuts and Jobs Act enacted in late 2017. Proposals to revise or restrict like-kind exchanges may have a significantly harmful effect on the value and trading of property.
Ensuring the nation has sufficient housing is an important public policy goal, and one that can be pursued through housing and tax policy. A critical way that the nation’s tax laws support investment in real estate is through Section 1031 like-kind exchanges.
Appropriately, retained for real property as part of the Tax Cuts and Jobs Act enacted in late 2017, the like-kind exchange rules encourage investors to remain invested in real estate by allowing property owners to defer tax on capital gains if, instead of selling their property, they exchange it for another comparable property. As long as the taxpayer remains invested in real estate, tax on any gain is deferred. When the taxpayer ultimately does sell the asset, the tax relating to the gain on the property is due. (An example of a like-kind exchange is offered below.)
Like-kind exchange rules play a crucial role in supporting the multifamily sector by encouraging investors to remain invested in real estate while still allowing them to balance their investments to shift resources to more productive properties, change geographic location, or diversify or consolidate holdings.
In addition, without like-kind exchanges, property owners would be deterred for tax reasons from selling assets that are in need of capital investment. Exchange rules allow those owners to transfer the property to new owners who can invest the necessary capital to revitalize the asset. Thus, like-kind exchange rules facilitate job-creating property upgrades and improvements. This incentive to invest is particularly critical given research commissioned by NMHC/NAA that shows the nation will need 4.3 million new apartments by 2035.
Like-Kind Exchange Example
Taxpayer A owns a 10-unit multifamily property worth $2 million. Her tax basis, or current investment interest, in the property is $1 million, leaving a $1 million taxable gain if she were to sell it. Taxpayer A wants to sell this property to purchase a $3 million, 15-unit apartment building. If she were to sell the first building and buy the second, she would have to pay tax on the $1 million gain, which at a minimum would reduce the capital available to invest in the new property and otherwise discourage her from pursuing the transaction.
With a like-kind exchange, she can exchange the assets and defer capital gains. In this transaction, she exchanges her property for the new one (with a loan to account for the remaining $1 million purchase price), and her tax basis in the new property increases to $2 million. The $1 million in capital gain from the sale of the 10-unit property is deferred until she sells the new asset. A like-kind exchange allows her to continue investing in job-creating real estate instead of being forced to hold properties solely for tax considerations.
Like-kind exchanges help efficiently allocate capital in the apartment industry and ensure that the industry can meet the demand for housing.
