Used by industries as diverse as rental cars and farming, 1031 exchangesaffect a broader swath of the business world than many commercial real estateexecutives realize, making them an even more significant part of the tax-reform issue, Passco Cos.’ president Larry Sullivan tells GlobeSt.com. With tax reform being a hot-button issue right now—and one of concern to the CRE industry—we spoke with Sullivan, an expert on the subject, about what we should know about tax reform and 1031 exchanges.
“First of all, I can only talk to you about tax reform as of this moment because it can change, and the whole situation is very fluid,” Sullivan tells us. “As I have told several conference audiences, expect the tax-reform journey to be a road trip filled with many rights, lefts, roundabouts and unexpected detours.
At this time, tax reform is at the stage of President Trump issuing what effectively amounts to a one-page summary and the House having a blueprint for tax reform from a year or so ago. There hasn’t been a public coalescing between Congress and the White House yet, so it’s tough to gauge where we are in the process.”
The House has only just commenced tax-reform committee hearings, and the Senate is consumed with the Obamacare repeal and replace, so tax reform hasn’t yet even taken shape over there, says Sullivan. “What we do know is that, so far, no one has mentioned anything about 1031 exchanges, on record, in any regard, so you have to remain thoughtful about the direction it might take going forward.”
We also know that 1031 exchanges have been around for 100 or so years, and many industries beyond real estate use it: aviation and automotive, just to name a couple, says Sullivan. “Its use impacts a wide part of the economy. I say that because the overarching goal of the White House in tax reform is making sure that GDP is over 3% and making sure that there are lots and lots of jobs created (or preserved) in the US—not in foreign countries. Promulgating job growth in America and raising the GDP to over 3% are the primary drivers of this Administration. Tax reform is a means to that end.”
1031 exchanges and the industries surrounding its use certainly impact job creation—probably wider than most people on the Hill realize. “The utilization of 1031s also contributes positive basis points to GDP,” says Sullivan. “So, the chances of a group attempting to eliminate something that would reduce jobs and lower GDP is not very high, from an intellectual standpoint. But sometimes intellectual standpoints don’t win in DC, and that is why the industry needs to remain very attentive.”
What we need to watch first is the repeal and replacement of Obamacare, Sullivan continues. “Why? Congress needs the repeal tax and cost saving (perhaps as much as $500 billion) to help tax reform remain revenue neutral and not create the opportunity to look for ‘pay for’ offsets (which could include 1031 exchanges). Second: the fate of the House-proposed border-adjustment tax. That tax, or something similar to it, could deliver another $1.2 trillion in budget buffer to the overall tax reform initiative and also insulate the need for ‘pay for’ offsets.”
Third, says Sullivan, Congress has proposed eliminating depreciation and replacing it with a new concept: immediate expensing. For example, you could buy an apartment project and immediately expense it (not including the land allocation) and carry forward any net losses. Some in Congress view this as a new alternative to 1031 exchanges. But no one knows the rules surrounding its implementation, and land is specifically excluded, so farm states are likely to not get on board. “You need to really watch that concept,” says Sullivan.
At this point, Sullivan says it’s too early in the game to know the fate of 1031 exchanges. When asked how investors’ views on 1031 exchanges might change if the tax benefits were removed, he says, “I don’t go with assumptions or conjectures. I don’t worry about what could happen nine or 12 months from now—or never. I focus on where we are today, and the next job is to make sure we’re informing congressmen and senators about what role 1031 plays in the overall job market and in the country’s overall economy. Keep building on that because it’s much brawnier than just the real estate side of things. Keep educating people.”
Finally, we asked Sullivan if, or when, tax reform is likely to happen. “I believe it will happen and will happen sometime between after October 1st of this year and the end of the first quarter of 2018.”
This article was originally published on GlobeSt.com.