Like-kind exchanges, a provision existing under section 1031 of the tax code allows an investor to defer paying capital gains taxes on certain assets when they use those earnings to invest in another, similar asset. This can be done again and again until the investor ultimately cashes out and protects against a needless lock out effect that would discourage investment.
In the perfect world, income from capital gains would not be taxed at all. The 23.8 percent tax hits income that has already been subjected to income taxes and is then reinvested to help create jobs, grow wages, and increase economic growth. This double taxation makes no sense from the perspective of encouraging investment and stronger growth.
The importance of like-kind exchanges led to 19 Members of Congress writing to urge the preservation of section 1031 like-kind exchanges in a letter to ways and Means Committee Chairman Kevin Brady (R-Texas).
In the absence of full repeal of the capital gains tax, Section 1031 is both vital and commonsense from an economic perspective. Because there is a continuity of investment from any 1031 eligible transaction, there is no reason to arbitrarily punish reallocation of resources. If anything, this provision should be expanded so all capital gains are treated the same as like-kind exchanges.
In fact, repealing this provision would have a damaging impact on our economy, resulting in lower investment and less incomes as proven by a study by Ernst and Young. If used to finance more government spending, repeal of section 1031 would cost the U.S. economy $13.1 billion in lost GDP year after year. Using like-kind exchanges as an offset for tax reform would be only marginally better, reducing annual GDP loss over the long term by $8.1 billion. This GDP loss would also result in investment falling by $7 billion every year and reduce labor income by an estimated $1.4 billion.
Because repeal would subject many business to higher taxes, it would reduce capital stock, labor productivity, and output. These factors would consequently result in longer holding periods and slow or restrict the transfer of capital within our economy because businesses would become arbitrarily discouraged from making investment decisions due to the tax consequences.
Until we abolish the capital gains tax within businesses, lawmakers should keep section 1031 because it reminds us of how moving in the right direction creates jobs, increases national income and wealth. It also serves as a good example. We should expand and enlarge, not repeal this provision.