Are 1031 Like-Kind Exchanges Going Away?
Understand the legislative and economic forces shaping the future of 1031 exchanges and what potential tax policy changes mean for real estate investors.
A like-kind exchange, governed by Section 1031 of the Internal Revenue Code, is a tax-deferral strategy for real estate investors. It permits an individual to postpone paying capital gains tax on the sale of an investment property by reinvesting the proceeds into a similar or “like-kind” property. This provision is a recurring subject in national economic debates, with its potential modification or elimination frequently discussed.
Current Proposals and Legislative Status
The future of like-kind exchanges has been amplified by the Biden Administration’s 2025 budget proposal. Similar to proposals in recent years, it does not call for a full repeal of Section 1031 but instead aims to cap the amount of capital gain that can be deferred.
The suggested limitation would restrict the deferral to $500,000 per taxpayer, or $1 million for married couples filing a joint tax return, annually. Gains exceeding these thresholds would become immediately taxable in the year the original property is sold. According to administration estimates, this cap could generate approximately $19.6 billion in additional tax revenue over a decade.
Despite being a recurring feature in budget proposals, the path to enactment is uncertain, as any change requires congressional legislation. The proposal to cap Section 1031 deferrals has previously been met with resistance and failed to advance.
Arguments Driving the Repeal Discussion
A primary argument for limiting Section 1031 is the perception that it functions as a tax “loophole.” This view holds that the provision disproportionately benefits wealthy individuals and large corporations, allowing them to defer tax payments indefinitely on real estate investments and contributing to economic inequality.
Another driver of the repeal discussion is the potential for increased federal tax revenue. By capping the deferral amount, the government would collect taxes on gains exceeding the proposed thresholds sooner. This projected revenue is often presented as a means to fund other government programs or reduce the federal deficit.
Finally, there is an argument that eliminating this provision would lead to a simpler tax code. The rules for 1031 exchanges add complexity to real estate transactions. Repeal would streamline the tax system by treating the sale of investment real estate more similarly to the sale of other assets.
The Case for Preserving Like-Kind Exchanges
Defenders of Section 1031 argue that it is a deferral mechanism, not a permanent tax avoidance tool, emphasizing that taxes are eventually paid. They assert that the provision stimulates the real estate market. By allowing investors to redeploy their capital into new properties, it encourages a higher volume of transactions, which supports associated industries and generates jobs.
The provision is also a tool for a diverse group of property owners. Farmers and ranchers use like-kind exchanges to relocate or expand their operations without incurring a prohibitive tax liability. Similarly, small business owners and middle-class investors use these exchanges to transition into properties that better meet their changing business needs.
Proponents also argue that limiting the provision could have negative long-term revenue consequences. The ability to exchange properties encourages investors to make improvements and acquire larger properties over time. This leads to greater appreciation and a larger tax bill when the property is eventually sold outright, potentially leading to greater overall tax revenue for the government.
Potential Taxpayer and Market Adjustments Without the Deferral
If the 1031 exchange were capped, the immediate consequence would be the timing of tax liability. For example, an investor selling a property with a $700,000 capital gain could defer the entire tax under current rules. With a $500,000 cap, $200,000 of the gain becomes immediately taxable, creating a new tax bill and reducing the capital available for the next investment.
This tax consequence could alter investor behavior, creating a “lock-in” effect where owners hold properties longer to avoid taxes. This reluctance to sell could reduce available properties, decrease transaction velocity, and lead to a less dynamic and efficient real estate market.