Rising capital gains taxes make 1031 Exchanges a smart tax strategy

Since the enactment of the Bush Tax Cuts in 2002, which cut the capital gains tax to a 70+ year low, the number of 1031 Exchanges has fallen by nearly 50%. This under-utilized tax strategy can defer capital gains tax indefinitely, and if current political trajectories continue, now may be the time to take advantage of them. Barring legislative intervention, the Bush Tax Cuts will expire at the end of this year. Congress is debating which, if any, portions of the cuts to extend. Expiration of the cuts will return tax rates to where they were during the '90s, and while there is bipartisan support for continuing the middle-class portions of the cuts, the tax cuts affecting higher-income Americans, including capital gains, are much more likely to expire, raising the capital gains tax rate to 20% from 15%. The new rate is still relatively low, compared to the average tax rate over the last century or so, but it will nevertheless have marketplace effects. For example, it is common with a capital gains tax raise to see a spike in liquidation, as some investors would rather realize their profits now, especially in a down economy, rather than wait the extra few years for the appreciation to offset the tax increase. If you are in a position to be strongly affected by the capital gains tax, you may want to start considering your liquidation options. In the midst of all this, a 1031 Exchange's tax deferment abilities look increasingly attractive to many investors. If you invest in commercial real estate, now is the time to take a look at 1031 Exchanges and see if they will be an effective way to mitigate your increased tax burden. Jed Dallek, CPA, MST, is a tax partner at Grassi & Co., Jericho, N.Y.