REDDIT reader worried about IRC §1031 tax-free exchanges

Here is a question I saw on the REDDIT real estate investment group.

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“Do you think the like-kind exchange will survive, or is its downfall inevitable?”

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Tax-free exchanges are authorized by 26 USC §1031, also known as §1031 of the Internal Revenue Code. Roughly, it says if you trade a business or investment real property for another business or investment real property, you are not required to pay the capital gains tax on the property you are getting rid of. Most such transactions are three-way trades, not two-way. One way is Joe wants my rental house. I want Bob’s house. So Bob deeds his house to Joe. Then I deed my house to Joe and Joe deeds Bob’s house to me. When the dust settles, everyone got what he wanted and my deeding my house to Joe and receiving Bob’s house is tax free.

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If I later sell Bob’s house, THEN I need to pay tax on both the gain I had before the exchange plus any gain that happened after the exchange on the house I got from Bob.

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I do not know if you followed that, but is typically lets you avoid gains taxes in the hundreds of thousands or millions of dollars.

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Big deal.

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Decades ago, they tried to repeal that law secretly. I got a frantic call from the National Multi-Housing Council. They said, “The Senate is trying to secretly end 1031 exchanges. We can’t get any media to pay attention. You seem to be good at getting media. Can you call one of your contacts in media and tell them about this?”

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“I’ll give it a try.”

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I called the then Wall StreetJournal real estate writer—Lawrence Ingrassia I think—and explained it to him. He was very interested. The following day, it was in the Journal. Front page I think. Real estate people, who were not aware this was happening, went nuts calling their Congress person and Senators.

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That ended it.

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I hear it mentioned from time to time but it never got close again that I know of.

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Over my long career, I saw them end installment sales (§453) twice I think. Both times, investors went nuts when they found out and it was repealed. They also tried to end stepped-up basis (1014), the biggest tax break in the Internal Revenue Code. They succeeded. But then taxpayers got hit with it and went nuts and it was repealed.

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They did succeed in passing the passive loss limits in 1986. That was a disaster and it is still law.

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Why do you ask this question? Are you just generally paranoid or have you heard something?

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IRC §121 lets you avoid gains tax on $250,000 per spouse on your principal residence, which is the only real estate investment you ever need. You can do that repeatedly. So no need for 1031 if 121 covers all or most of your gain.

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If and when your gain exceeds that, you should turn your principal residence into a rental house for a few years, then 1031 exchange it for a more expensive rental house and rent that for a couple years, then move in and make it your home.

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This history indicates getting rid of 1031 is unlikely. Unless you know something about currently-pending legislation, unlikely is the correct situation.