Commercial real estate economy will not recover if 1031 exchanges are capped

Christopher Sassone

An essential tool in the rebuilding of our American economy is at serious risk as part of the $1.8 trillion American Families Plan Congress is considering — and the damage will be felt in every state, city and town still reeling from the ravages of COVID-19. 

For the last century, like-kind exchanges — which allow investors to defer taxes on the sale of a property if the proceeds are reinvested in a new property — have been a cornerstone of the commercial real estate market, generating economic benefits on every level which far exceed the amount of taxes deferred. The $1.8 trillion plan presented by the president proposes to cap the gains that can be deferred at $500,000. 

Jennifer Jones

This shortsighted and counterproductive cap is a recipe for economic stagnation, not recovery.  

Every community in the nation, including those here in Rochester and across New York state, has witnessed the closing of shopping malls, strip centers, and restaurants due to the pandemic, not to mention the significant fallout felt by hotels and office buildings. A substantial reinvestment to repurpose and redevelop these commercial spaces will be required for the economy to regain its strength. 

The Federation of Exchange Accommodators, a national organization, analyzed the data from five companies in New York between 2015 and 2019 and found: 

• 10,663 properties involved in exchanges; 
• Those properties represent a total value of $43.5 billion; 
• Those transactions generated $2.4 billion in state and county transfer taxes, mortgage taxes and recording fees for state and local governments. 

Dan Wagner

This is just a portion of the market as there are many more companies that facilitate exchanges. It is estimated that 15 to 20% of all commercial transactions involve a 1031 exchange, which provides fundamental liquidity to real estate. It is clear that Section 1031 is important to the real estate economy in New York and that it generates significant tax revenue for state and local governments. 

A restrictive cap — whether $500,000 or any other amount — on the ability to redevelop commercial properties would send an already-struggling commercial real estate market into a tailspin.  

Some argue that the provision is a “loophole” used to avoid taxes on gains, but in reality, a 1031 exchange is a deferral of tax, not an elimination. Taxes are paid over a 15-year window. According to a study, 80% of the taxpayers do only one 1031 exchange and then dispose of the property in a taxable sale.  

A 2017 macroeconomic study by Ernst & Young, recently updated, concluded that if section 1031 were limited or repealed, it would shrink GDP. 

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 budget estimate of $1.95 billion per year over 10 years coming from a $500,000 cap on 1031 exchanges. Why change Section 1031? It doesn’t raise any money.  

The resurgence of our economy will need to be generated from many sources, and the private sector must again play a significant role in the recovery. The best way to encourage improvements and strengthen this infrastructure stock is to keep section 1031 unchanged to encourage investment and, most importantly, reinvestment in the real estate economy. 

Christopher L. Sassone, CFP®, CLTC® is a CERTIFIED FINANCIAL PLANNER™ with Davie Kaplan Wealth Care Advisors, LLC in Rochester, New York.  

Jennifer R. Jones, CPA is the Chief Executive Officer & Shareholder with Davie Kaplan, CPA, P.C. in Rochester, New York 

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®. 

Securities offered through Avantax Investment Services℠, Member FINRA, SIPC. Investment Management Solutions (IMS) Platform programs and services offered through Avantax Advisory Services℠. All other financial planning services are offered through Davie Kaplan Wealth Care Advisors, LLC. Davie Kaplan Wealth Care Advisors, LLC is not affiliated with Avantax Investment Services℠. Insurance services offered through an Avantax affiliated insurance agency or Davie Kaplan Wealth Care Advisors, LLC. 

Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.