Capping 1031 exchanges threatens ability to reinvest in minority communities
The proposed cap on 1031 exchanges at $500,000 included in the plan is shortsighted and counterproductive
A critical investment tool which has been central to the rebuilding of our American economy – especially in diverse communities – is at serious risk as a provision in the $1.8 trillion American Families Plan is under consideration in Washington, DC.
The proposed cap on 1031 exchanges at $500,000 included in the plan is shortsighted and counterproductive. A cap on 1031 exchanges right now would severely restrict the ability and willingness to reinvest in commercial real estate and redevelop properties at a time in our nation’s economy when eager, courageous, and committed investors are needed more than ever.
IRC 1031 like-kind exchanges have allowed investors to defer taxes on the sale of a property if the proceeds are reinvested in a new property. 1031 exchanges have always been a cornerstone of a healthy and vibrant commercial real estate market. An academic study by Professors Ling and Petrova confirmed that investors who leveraged 1031 exchanges made appreciably greater capital investment into their properties than those without an exchange.
Strategic reinvestments to redevelop underperforming properties have generated immediate economic benefits – including jobs, labor income, property taxes and Federal taxes – far in excess of the Federal taxes deferred.
Without 1031 exchanges, many of my (Lippitt) clients would do nothing. Currently, investors large and small can defer taxes, add capital, and buy property that wouldn’t be possible without 1031. Some use it to upsize, others to downsize. Either way, the taxes are paid in full at upon sale.
Needed Capital for in Underserved Communities
More recently, the Black American community has increased its share of the commercial real estate investment market through the prudent use of 1031 like-kind exchanges, making a critical reinvestment in their communities while building personal wealth.
Investors are transforming underserved communities by turning outdated or distressed properties into beneficial uses such as renovating affordable multifamily housing or reinvigorating abandoned retail centers and strip shopping centers that have lost their anchor – activity which creates both temporary construction jobs and full-time permanent jobs in the community.
Growing businesses use it to relocate and expand when they’ve outgrown existing space. Section 1031 allows them to keep more capital in their business which enables them to expand and add employees with less debt.
The Federation of Exchange Accommodators, the national organization of 1031 Exchange companies, analyzed the data from just 7 companies in Colorado during 2015 to 2019 and found:
- 14,147 properties were involved in exchanges;
- These properties had a total value of $21.7 billion;
- These transactions generated $3.5 million in state and county transfer taxes and recording fees in Colorado.
That is just a small portion of 1031 activity as many companies facilitate 1031s in Colorado. One in five commercial real estate transactions involve a 1031 exchange. It provides fundamental liquidity to real estate. It is clear Section 1031 is important to our region’s economy, and generates significant tax revenue – state income tax, increased property taxes and transfer taxes – much of which would be lost with a cap or change to Section 1031.
Why Capping 1031 is a Loser
A 2019 macroeconomic study by Ernst & Young concluded that if section 1031 were limited or repealed, it would shrink GDP. The study further projected benefits from 1031 exchanges nationally for 2021 and concluded that 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 would you cap 1031? It doesn’t raise any money.
For many middle-class Black Americans, 1031 like-kind exchanges have presented new opportunities – the opportunity to plan for a comfortable retirement, create intergenerational wealth, and grow business interests organically without overreliance on debt. And an opportunity to reinvest in their community. As a Black American business owner, I (Nesbitt) utilized a 1031 exchange to trade out of a Chicago apartment building into an office building in the South Metro Denver market. Owning a building has allowed me save thousands of dollars in rent while building equity in commercial real estate and planning for my retirement.
A cap on 1031 exchanges at any level would remove those opportunities and reinstall daunting barriers to the commercial real estate marketplace. Section 1031 provides important capital to revitalize communities throughout Colorado Springs, Denver-Aurora area and the entire state to grow our economy.
Eric L. Nesbitt is a dual-licensed real estate attorney and commercial real estate broker. He is a shareholder in the Law Offices of Eric L. Nesbitt, P.C. (www.nesbittlawoffices.com), and the founder and principal of the commercial real estate brokerage firm, The Nesbitt Commercial Group (www.nesbittcommercial.com) with Keller Williams DTC and KW Commercial. He is also the Past President of the Denver Metropolitan Commercial Association of Realtors (DMCAR).
Marc S. Lippitt is President of Unique Properties, Inc., which he founded in 1974. Marc has consistently been recognized as one of Colorado’s top real estate brokers. He is a Past President of the Denver Metropolitan Commercial Association of Realtors. www.uniqueprop.com.