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 the COVID-19 pandemic which shuttered countless shopping malls, retail centers and restaurants. The fallout continues with hotels and office buildings as virtual meetings are replacing business travel, and many people continue to work from home exclusively.
As every state in the nation, California especially, begins to creep toward an economic rebound, commercial real estate must again play an essential role in that recovery. The Biden administration 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.As regularly reported right here in the pages of this journal, Section 1031 has provided important capital to revitalize communities throughout the San Fernando Valley area to grow our economy. A considerable number of multi-family housing developments and commercial space in the Valley area has been purchased through the use of 1031 exchanges. It has been consistently used here to provide affordable multifamily housing in working-class communities, reimagine commercial shopping centers, and allow growing businesses to expand their space. The Federation of Exchange Accommodators, the national organization of 1031 Exchange companies, analyzed data from seven companies across California covering 2015 to 2019 and found:• 72,787 properties involved in exchanges;• those properties have a total value of $160.3 billion;• those transactions generated $2.74 billion in transfer taxes, mortgage taxes and recording fees for the state and local municipalities.That data is from just seven companies; actual 1031 activity in California is far greater as there are many companies supporting exchanges. It is clear Section 1031 is important to our region’s economy and generates significant tax revenue – much of which would be lost with a cap or change to Section 1031.A common misconception fueling attempts to remove 1031 exchanges is that they are a loophole to avoid paying taxes.
That is not the case. A microeconomic study on 1.6 million properties concluded that 80 percent of replacement properties acquired in a 1031 exchange were ultimately disposed of through a taxable sale, rather than a subsequent exchange, with all the deferred taxes paid within roughly a 15-year window.
Additionally, a 2017 macroeconomic study by Ernst & Young, recently updated, concluded that if section 1031 were limited or repealed, it would shrink GDP by a whopping $9.3 billion per year.The study further projected benefits from 1031 exchanges for 2021 and concluded that, on a national basis, these transactions will:• support 568,000 jobs, representing $27.5 billion in labor income and generating $5 billion in federal income taxes;• generate $6 billion annually in federal taxes from foregone depreciation on replacement properties;• generate $2.8 billion in state and local taxes;• add $55 billion to the GDP.Just the $5 billion in federal taxes from jobs in one year far exceeds the 2021 Biden administration budget estimate of $1.95 billion per year over 10 years coming from a $500,000 cap on 1031 exchanges. Why change Section 1031? The change wouldn’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. 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 the San Fernando Valley area – 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.
Victor Martinez is the principal, founder and president of Martinez and Associates, a specialized brokerage, management and consulting service for sellers and investors of manufactured home communities and self-storage facilities that is headquartered in Ontario and active in the Valley area. 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.
Danger in Plan to Eliminate 1031s
