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Home / Commentary / Danger lurking in Biden plan to eliminate or cap 1031s 

Danger lurking in Biden plan to eliminate or cap 1031s 

DJ Thompson is a senior director and office/investment specialist on the Cushman & Wakefield Pacific Office team in Boise. Submitted photo

The strength and resilience of the commercial real estate market has been tested many times over the last 100 years — never more so than during these past 16 months as the COVID-19 pandemic shuttered countless retail centers, strip shopping centers, shopping malls and restaurants. It is estimated that up to 25% of the strip shopping centers will go bankrupt. The fallout continues in hotels and office buildings. Virtual meetings will permanently replace significant business travel, and many people will work from home exclusively.

As every state in the nation, Idaho especially, begins to creep toward an economic rebound, commercial real estate must again play an essential role in that recovery. The Biden plan to eliminate the ability to defer taxes on property gains over $500,000 from like-kind exchanges of real estate, which is granted under Section 1031 of the Internal Revenue Code, will cripple commercial redevelopment at a time when our communities need that investment more than ever.

Section 1031 brings important capital to revitalize communities in Boise, the Treasure Valley and across all of Idaho. It has been used to provide affordable multifamily housing in working-class communities and revitalize strip shopping centers.

The Federation of Exchange Accommodators, the national organization of 1031 exchange companies, analyzed and aggregated the data from five companies in Idaho. The data covered 2015 to 2019. They found that there were 1,771 properties involved in exchanges during that period. Those properties had a total value of $2.3 billion. This is not a comprehensive total. There are many more companies that facilitate exchanges. It is estimated that 15% to 20% of all commercial transactions involve a 1031 exchange. It provides fundamental liquidity to real estate. It is clear that Section 1031 is important to the real estate economy in Idaho.

An all-too-common misconception, and one which has often fueled attempts to remove the provision, is that 1031 exchanges are a loophole to avoid the payment of taxes. That is not the case. A microeconomic study on 1.6 million properties conducted by professors David C. Ling (University of Florida) and Milena Petrova (Syracuse University) concluded that 80% of replacement properties acquired in a 1031 exchange were ultimately disposed of through a taxable sale, rather than a subsequent exchange, with all of the deferred taxes getting paid within roughly a 15-year window.

Additionally, a macroeconomic study initiated by Ernst & Young in 2017, and recently updated, concluded that if section 1031 were limited or repealed, it would shrink gross domestic product (GDP).  It further examined the potential benefits from the use of 1031 exchanges for 2021 and concluded that transactions from Section 1031 exchanges will support 568,000 jobs (260,000 in businesses using 1031, and another 308,000 from suppliers to those businesses), generating $27.5 billion in labor income which in turn will generate $55 billion value added to the GDP. Additionally, it will generate $5 billion in federal taxes from the jobs plus $6 billion per year of additional federal income taxes due to foregone depreciation (reduced deductions) on the replacement property and $2.8 billion state and local taxes.

Daniel Wagner is senior vice president of government relations for The Inland Real Estate Group of Companies. Submitted photo

Just the $5 billion generated from the jobs in one year far exceeds the estimate in the 2021 Biden budget that says capping 1031 at $500,000 raises on average of $1.95 billion per year over 10 years.

Why would anyone change Section 1031?  It doesn’t raise any money.  

Clearly the benefits gained by the national — as well as local — economies from 1031 exchanges far exceed the assumed cost to the U.S. Department of the Treasury from these temporary tax deferrals — with “deferral” being the operative word.

In the end, the Treasury receives its money; state and local entities enjoy the annual increased taxes generated by the healthy redevelopment of commercial property and the local and regional economy is strengthened through the creation and retention of jobs.

Eliminating or capping 1031 exchanges — which serve as an essential generator of economic redevelopment, jobs and local tax revenue for Idaho — would fall far short as an expected source to pay for the American Families Plan, and ultimately have the unintended consequence of harming, not helping, our towns, our cities and our American families who have struggled mightily from the ravages of the pandemic.

DJ Thompson is a senior director and office/investment specialist on the Cushman & Wakefield Pacific Office team in Boise. 

Daniel Wagner is senior vice president of government relations for The Inland Real Estate Group of Companies. He is past president of the Chicago Association of Realtors.

 

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