1031 Tax Reform Update – July 2015
Section 1031 matters. In fact, like-kind exchanges matter a lot. The second of two important economic impact studies, along with results of a large scale real estate industry survey, were released last week, quantifying the importance of I.R.C. Section 1031 to US real estate markets and to economic growth.
Using the most comprehensive database of US commercial real estate activity, more than 1.6 million real estate transactions spanning the 17 year period from 1997 to 2014, and totaling $4.8 trillion, were analyzed in a study by Dr. David Ling (University of Florida) and Dr. Milena Petrova (Syracuse University). The professors reported their findings in, “The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate”.
The microeconomic Ling-Petrova study, focused solely on commercial real estate, is consistent with, and builds upon, the macroeconomic Ernst & Young study released in March 2015, which found that
1) Section 1031 exchange transactions are fundamental to the strength and growth of the overall US economy, and
2) if repealed, GDP would drop by $81 – $131 billion over ten years
Major findings of the Ling-Petrova study are:
- Nationally, use of like-kind exchanges is widespread, accounting for almost 1 out of 5 real estate transactions
- Like-kind exchanges encourage greater capital investment, which leads to job creation. On average, taxpayers engaging in a 1031 Exchange acquire replacement properties that are approximately 33% more valuable than properties that are acquired after relinquished property was disposed through a taxable sale
- Exchanging taxpayers neither avoid nor indefinitely defer taxes:
1) In 34% of exchanges, some federal tax was paid in the year of the exchange
2) In 88% of exchanges, the replacement property is disposed through a taxable sale, rather than a second 1031 Exchange.
3) Taxpayers paid nearly 19% more in taxes when an exchanged replacement property was ultimately sold than would have been due had a non-exchange property (acquired after an ordinary sale) been sold
- Section 1031 investors used less debt and more equity in replacement properties, reducing financial system-wide risk and making the market more stable
The Ling-Petrova study predicted that if Section 1031 was repealed, real estate values would drop, long term rents would rise, and real estate transactional activity would decline.
The authors concluded: “Like-kind exchanges are associated with increased investment, shorter holding periods, and lower leverage…the removal of exchanges will lead to a decrease in investment, an increase in holding periods (decrease in liquidity) and increase in the use of leverage to finance acquisitions. These micro effects are likely to have macro-economic consequences as well. For example, decreased construction and investment activity in commercial real estate markets will depress employment…”
Confirming these findings, the National Association of Realtors® (NAR) released its report, “Like-Kind Exchanges: Real Estate Market Perspectives 2015” with the results of a survey of 100,000 of NAR’s commercial and residential REALTORS® which found that:
- 63% of responding REALTORS® participated in a like-kind exchange transaction between 2011 and 2014
- At least 40% of real estate transactions during the same period would not have occurred without a 1031 Exchange
- 56% of respondents said that without Section 1031, projects likely would have been smaller in scale
- 96% of respondents also predicted that real estate values would decrease if Section 1031 was repealed
“The two economic impact studies and NAR’s survey report provide valuable information for our policy makers. They quantify that Section 1031 not only stimulates transactional activity, it provides a powerful catalyst for broad, job creating, economic activity upstream and downstream from the actual exchange transaction. The bottom line is that owners maintain, but buyers rejuvenate and improve properties. Section 1031 enables exchanging buyers to maximize capital investment, resulting in improved communities and a healthy economy,” summarized Suzanne Goldstein Baker, General Counsel of IPX1031®.
For more information
Suzanne Baker, General Counsel of IPX1031®
email@example.com or 312.223.3003