1031 Capital Gains Deferrals: Good For The Economy, Good For Investors

A 1031 exchange is a method used by real estate investors to indefinitely defer capital gains tax liability on a property's sale. This is done by giving the rights to a property that one plans on selling to an intermediary, who holds on to the sale proceeds and uses them to purchase a replacement that complies with the rules set out in Section 1031 of US tax code.

While the present interest in the 1031 could give you the impression that it only recently came on the scene, this is untrue. Actually, the history of the 1031 exchange extends as far back as 1921, though it was originally was quite different from the exchange we know and love. Section 1031 truly came into its own in the 1970s, which saw many important modifications in the way in which exchanges were conducted. These modifications resulted in a more powerful conception of the process and created greater interest from investors.

The capital gains deferral an exchange grants to the taxpayer may, at first, seem to be a gift given by the United States government, however it is, in reality, closer to an interest free loan, because there is an expectation that the investor will “repay” the money gained from the capital gains tax deferral by accepting capital gains liability on the subsequent sale of a replacement property. Additionally, this interest free loan is one that may be kept by the investor indefinitely; an investor may conduct any number of exchanges before finally electing to make an outright sale, on which capital gains taxes must be paid.

Section 1031 of US tax code constitutes a mutually beneficial agreement between the investor and the United States government, profitable for the U.S. economy as a whole as well as the individual taxpayer. By viewing the transfer of value in an exchange as an extension of an existing investment instead of as a separate transaction liable to be taxed, investors are given the opportunity to transfer their money to the most profitable possible investments. This, in turn, helps to elevate the country's economy by encouraging job growth.

Like anything else, Section 1031 has skeptics. Some advocates of change in Section 1031 will pose the argument that the tax free profit gained by to the taxpayer in the exchange process creates an unreasonable advantage over other buyers. Another frequent issue of concern is that the strictness of the time limits attached to some aspects of the 1031 procedure may promote an atmosphere of frantic buying, resulting in an increase in asking prices for replacement properties. These criticisms, however, are only loosely based in hard evidence, and the odds that the 1031 exchange will go through significant change in the near future are quite slim. In general, most will concede that Section 1031 is greatly helpful to all involved, as it allows investors increased profits on the sale of property while additionally promoting the creation of jobs and therefore the greater good of the country as a whole. There is little doubt that the 1031 exchange will be a part of the investment world for years to come.

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