By Manuel Ramirez and Daniel Wagner
An essential tool in the rebuilding of our American economy is at serious risk as part of the $1.8 trillion American Families Plan being considered in Washington — and the damage will be felt in every state, city and town still reeling from the ravages of COVID-19.
For the last 100 years, 1031 like-kind exchanges, which allow investors to defer taxes on property sale gains while reinvesting that money into new properties, have been a cornerstone of the U.S. commercial real estate market, generating economic benefits on every level which far exceed the amount of taxes deferred. The $1.8 trillion plan presented last month by President Joe Biden proposes to cap the amount of gains that can be deferred at $500,000.
This shortsighted and counterproductive cap is a recipe for economic stagnation, not recovery.
Every community in the nation, including those in San Diego and all across the state of California, have witnessed the closing of countless shopping malls, strip centers, and restaurants due to the pandemic. The fallout continues in hotels and office buildings. Virtual meetings will permanently replace significant business travel, and many people will work from home exclusively.
A substantial reinvestment to repurpose these properties and redevelop commercial spaces will be required for the economy to regain its strength. Section 1031 provides important capital to revitalize communities in San Diego and throughout Southern California and grow our economy.
The Federation of Exchange Accommodators, the national organization of 1031 exchange companies, analyzed and aggregated the data from seven companies in California from 2015 to 2019 and found:
- 72,787 properties involved in exchanges
- Total value of exchanges of $160.3 billion
- $2.74 billion generated in transfer taxes, mortgage taxes and recording fees for California
It is estimate 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 Southern California and that it generates significant tax revenue for both county and city governments.
Proponents of the cap argue that the provision is a “loophole” used to avoid payment of taxes. In reality, a 1031 exchange is a deferral, not an elimination of tax. According to a study, 80% of the taxpayers do only one 1031 exchange and then dispose of the property in a taxable sale which means the taxes get paid in roughly a 15-year window.
A restrictive cap on the ability to reinvest into commercial real estate and the redevelopment of properties at this critical juncture in our nation’s economy would send an already struggling commercial real estate market into a tailspin.
Ernst & Young estimated that the reinvestment through 1031 exchanges in 2021 will support more than 560,000 new jobs paying more than $27.5 billion in labor income, generate $5 billion in Federal taxes, add $55 billion to the GDP. That $5 billion in Federal taxes generated 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.
So why would anyone change Section 1031? It doesn’t raise any money.
The truth is, like-kind exchanges play a critical role in many facets of the nation’s economy, including:
- Fueling the redevelopment of distressed retail and commercial properties
- Financing the construction or renovation of multi-family and affordable housing
- Allowing business to move to bigger facilities while keeping their capital in the business
- Allowing the middle class to build a real estate portfolio which will one day fund retirement
- Supporting farmers, ranchers, and forest owners
- Promoting land conservation and environmental protection
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.
Manuel Ramirez is chairman of RJI CPAs and a founding member of the Irvine-based firm. He was appointed by Gov. Arnold Schwarzenegger to the California Board of Accountancy in 2007 and elected president of the California Board of Accountancy in 2010.
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.
This article was originally published by Times of San Diego.