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A FOWL VIEW OF THOSE
WHO WOULD CHANGE SECTION 1031

The view taken by those who propose to alter the nature of Section 1031, as it applies to investment real estate, is shortsighted and, if enacted will have exactly the opposite of the desired effect. That is to say, it will actually lead to a DECLINE in tax revenues. Here's why:

The underlying assumption is that people will continue to exchange their properties upward (into larger projects) even if they have to pay a tax to do so. Actually, many investors will simply choose to keep their present investments, rather than pay a tax on their equities for the privilege of investing more in the economy. You see, most exchanges are voluntary, not mandatory. When people cease to voluntarily move their investments upward, there are many effects, mostly bad, as I will show you, and not the least of which is that LESS taxes will be collected.

The problem in the perception of those who would change Section 1031 is that they are examining only the narrower picture - that of the individual transaction where the property is DISPOSED of. They are failing to look at the bigger picture. In every case, if taxation is to be deferred, the investor must use that money to acquire at least as large an investment property. In fact, in almost every case, the investor uses the money to acquire an even larger real estate investment property (otherwise there would be no point to doing the deal in the first place, since the investor would be merely replacing one investment with another one of the same size). The key question, which is not being asked is: WHAT HAPPENS TO THAT MONEY ? The answer is simple: The money goes, almost immediately (simultaneously, or within 180 days at the very most) into the hands of another real estate investor who is disposing of property at a profit (and all of the middlemen: brokers, title companies, banks, county tax assessors, escrow companies, etc. who facilitate the transaction and pay taxes on their portion). That investor either pays taxes on it, or Section 1031 is used to put the money into a yet larger investment. If Section 1031 is utilized, the money moves up the line to the next investor, and so on. Even if you assume that all investors are clever and use Section 1031 to move up in their investments (which is, as a practical matter, not true), rather than pay the tax and keep the profit, ultimately, someone keeps the money and pays the tax. In the real world, this usually turns out to be the real estate developer who is selling a large project, and who pays taxes on the project since it is inventory. The point is this:

EVERY PENNY OF THE MONEY REALIZED ON THE FIRST TRANSACTION IS ALREADY BEING TAXED. THE TAX IS PAID BY EITHER THE MIDDLEMEN (BROKERS, BANKERS, ETC.), OR THE ULTIMATE SELLER WHO KEEPS THE PROFIT.

What's more, in the real world, the amount of money moving up the investment ladder usually gets BIGGER with each transaction. This happens because, in a typical transaction, the investor's profit from his old property is added to the net loan proceeds from a new loan on the property being acquired and the total given to the investor who is disposing of the new property. Thus, the selling investor usually ends up with a larger profit than the investor who has purchased his property. And the selling investor will either pay tax on this larger sum of money or move it up the line to the next bigger investor.

Where does all of this economic activity begin ? It begins with the small investor who wishes to increase his investment. It is his dollars that start the train rolling. His investment is rapidly magnified many times over, as each transaction creates yet another transaction, bigger than the last; And, taxes ARE paid on the last and biggest transaction, not to mention all the way along by those people who facilitate the transactions such as brokers, banks, title companies, escrow companies, contractors, etc., ad infinitum.

The exchange investor is truly the goose that lays the golden egg. And how will the proposed changes to Section 1031 treat this most important person ? It will tax him on money that he does not receive, money that he is willing to pass along, up the line, money that will grow and grow, like a snowball, into a really big pile of money that WILL have taxes paid on it. To be honest, it is hard to imagine a more counterproductive proposal than one that would change Section 1031. What is being proposed is that we kill the goose instead of collecting its golden eggs.

Are we really that stupid ?