Rarely do the interests of small businesses owners, multigenerational family farmers, and a broad range of local entrepreneurs agree with almost a century of federal income tax policy — especially when it results in billions of dollars in taxes being paid.
But fortunately for the economy, they do.
The trouble is, that this powerful economic driver now is in real danger as Congress and the Trump administration grapple with the twin dilemmas of tax reform and a threadbare federal budget proposal that would put such long-term investments and incentives at risk.
Simplification of the tax code and the elimination of unfair loopholes are noble intentions indeed, but mistaking a positive revenue and economic driver for a negative, and putting billions of dollars of tax revenue and sustained economic growth in the crosshairs is unwise, especially as small-business owners stand to be hit the hardest.
For more than 90 years, like-kind exchanges (under Section 1031 of the Internal Revenue Code) have been a key enabler for small businesses and investors to expand their businesses by exchanging rental or business-use real estate for other rental or business-use real estate without an immediate tax penalty.
Just like a 401(k) or IRA where the tax payment on the gain is deferred until it’s withdrawn, like-kind exchanges make it possible for small-business owners to grow and exchange their real estate as markets change and then pay the full amount of the resulting tax burden when the property ultimately is sold rather than exchanged.
For example, a farmer who sells one piece of land, via like-kind exchange, for another piece of land (which usually is bigger and/or closer to the primary acreage) incrementally grows the business, while deferring the taxes. Once the landowner sells the second property instead of exchanging it, the total amount of taxes owed on the gain are paid.
So, too, is this the case for owners who — as the result of a decline in their health or a need to retire — no longer are able to maintain a property, an event that can negatively impact all of those who rely on it. By way of example, in commercial property exchanges, about 88 percent of replacement properties acquired in a like-kind exchange eventually are disposed of in a taxable sale — where the tax is eventually paid.
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Today, the capital requirements that small business owners and farmers face is enormous, and growing. Without the ability to turn to a like-kind exchange, many owners will, sadly, allow the asset to fall into disrepair because the cost of sale is too high. The number of dilapidated apartment buildings, neglected farms and vacant store fronts is destined to increase if the owner is faced with a sale where an immediate tax payment robs them of their ability to fully reinvest and grow for the long term. With a 1031 exchange, however, a new owner will emerge to improve the property (hiring contractors and others in the process) and stimulate the economy as the prior owner transitions.
Moreover, during the post-2008 economic downturn, like-kind exchanges made it possible for real estate transactions to continue to occur. But for this tool, that market would have frozen to an even greater degree, just at the time when the economy could least afford it.
A 2015 Ernst & Young study found that the failure to keep like-kind exchanges intact would result in the contraction in overall U.S. GDP of approximately $8.1 billion annually. The loss to GDP over a 10-year period was predicted to be $61 billion to $131 billion, depending on how that revenue is ultimately replaced.
As the backbone of the nation’s economy, small-business owners and farmers like me know what it takes for small businesses to thrive, and how — contrary to popular perception — government can help. The opposite of a Washington-run program, like-kind exchanges wisely replace mandates from bureaucrats with locally focused and customized marketplace solutions.
For Congress and the White House the next step is clear and obvious — like-kind exchanges work just as they always have. Putting such a continuous circle of economic stimulus and liquidity at risk threatens adverse consequences, with far too little offered in return.
• Judd Vande Voort is a fifth-generation farmer, who operates a corn and soybean farm in Southeast Iowa with his family. He has a B.A., M.S., and law degree from the University of Iowa.