Opinion: Capping 1031 Exchanges Is a Recipe for Stagnation in Commercial Real Estate Development
Workers build a housing estate in West Oakland. Photo by Anne Wernikoff for CalMatters
An essential tool in rebuilding our American economy is seriously at risk under the US $ 1.8 trillion family plan under consideration in Washington – and the damage will be felt in every state, city, and town that are still affected by the ravages of COVID-19.
Over the past 100 years, 1,031 like-for-like exchanges, which allow investors to defer taxes on property sales profits while reinvesting that money in new real estate, have been a cornerstone of the U.S. commercial property market, bringing economic benefits at all levels. Exceed the amount of deferred taxes. The $ 1.8 trillion plan unveiled last month by President Joe Biden is to cap the amount of profits that can be deferred to $ 500,000.
This short-sighted and counterproductive cap is a recipe for economic stagnation, not recovery.
Every community in the country, including those in San Diego and across the state of California, has seen countless malls, malls, and restaurants close due to the pandemic. The fallout continues in hotels and office buildings. Virtual meetings will permanently replace major business travel and many people will work exclusively from home.
In order for the economy to regain its strength, considerable reinvestment is required to convert this property and to develop new commercial space. Section 1031 provides vital capital to revitalize communities in San Diego and all of Southern California and grow our economies.
The Federation of Exchange Accommodators, the national organization of 1,031 exchange companies, analyzed and aggregated data from seven companies in California from 2015 to 2019 and found:
- 72,787 properties that are involved in stock exchanges
- Total value of the exchange of $ 160.3 billion
- $ 2.74 billion in California transfer taxes, mortgage taxes, and admission fees
It is estimated that 15 to 20% of all trade transactions involve a 1031 exchange. It provides basic liquidity for real estate. It is clear that Section 1031 is important to the Southern California real estate industry and generates significant tax revenues for both the county and city governments.
Proponents of the cap argue that the provision is a “loophole” to avoid paying taxes. In reality, a 1031 exchange is a deferral, not a tax exemption. According to a study, 80% of taxpayers only do a 1031 swap and then sell the property in a taxable sale, meaning taxes are paid in roughly a 15 year window.
A restrictive upper limit for reinvestment in commercial real estate and redevelopment of real estate at this critical juncture in our country’s economy would spin an already ailing commercial real estate market.
Ernst & Young estimates that reinvestment through 1,031 exchanges will create more than 560,000 new jobs in 2021, paying more than $ 27.5 billion in labor income, generating $ 5 billion in federal taxes, and $ 55 billion contribute to GDP. That $ 5 billion in federal taxes generated in one year far exceeds the estimate in the Biden 2021 budget, which says an upper limit of $ 1031 to $ 500,000 averages $ 1.95 billion each Year is increased over 10 years.
So why would anyone change section 1031? It doesn’t make any money.
The truth is that exchanges of a similar nature play a vital role in many facets of the country’s economy, including:
- Promotion of the redevelopment of distressed retail and commercial properties
- Financing the construction or renovation of apartment buildings and affordable housing
- Enable companies to move to larger facilities while their capital stays in the company
- Allowing the middle class to build a real estate portfolio that will one day finance retirement
- Support for farmers, ranchers and forest owners
- Promotion of land and environmental protection
The recovery of our economy must come from many sources and the private sector must once again play a major role in the recovery. The best way to encourage improvements and strengthen this inventory of infrastructure is to leave section 1031 unchanged to encourage investment, and most importantly, reinvestment in the real estate industry.
Manuel Ramirez is the chairman of RJI CPAs and a founding member of the Irvine-based company. He was appointed to the California Board of Accountancy by Governor Arnold Schwarzenegger in 2007 and elected President of the California Board of Accountancy in 2010.
Daniel Wagner is Senior Vice President of Government Relations at The Inland Real Estate Group of Companies. He is a past president of the Chicago Association of Realtors.