Proposed Cap On 1031 Exchanges Would 'Cripple' CRE markets

President Biden’s proposed cap on Section 1031 like-kind exchanges would drastically curtail economic activity and effectively cripple CRE markets, according to a new analysis by Ernst & Young using Federation of Exchange Accommodators data.

Section 1031 exchanges are predicted to add 568,000 jobs and $27.5 billion in labor income to the national economy and $55.3 billion to the US gross domestic product in 2021, according to the FEA. E&Y also says like-kind exchanges will generate approximately $7.8 billion in federal, state and local taxes this year. Foregone depreciation on replacement properties will generate $6 billion per year in income tax revenue.

The Biden Administration has proposed capping gains deferred under 1031 exchanges at $500,000 as a means of paying for the $1.8 trillion American Families Plan.

“A cap on like-kind exchanges would effectively eliminate Section 1031 and cripple the commercial real estate market,” said FEA President Julie Baird. “Many large commercial properties such as hotels, office buildings and retail spaces need to be reimagined or renovated as a result of the pandemic. These exchanges generate jobs for people such as contractors, construction workers, building material suppliers and many more. Without Section 1031, people will simply hold onto their properties instead of repurposing them.” 

1031 exchanges account for between 10 to 20% of all commercial real estate transactions, and 1031 buyers also typically invest more capital into replacement properties.

“It’s a myth that Section 1031 is a loophole for the wealthy to avoid paying taxes,” said Baird. “Section 1031 is used by a broad variety of taxpayers and the overwhelming majority of those who utilize like-kind exchanges eventually sell the replacement property in a taxable sale.”

The cap on 1031 exchanges is expected to have a significant impact on the net lease sector, with some experts estimating that the CRE market could be hit by as much as 12 to 15% under the Biden plan.

“The plan, as it stands, would be detrimental to the net lease industry,” John Feeney, senior vice president of The Boulder Group, told GlobeSt.com last month. “I would say the majority of the exchanges that occur in net lease would fall above that $500,000 limit.”

And while the changes have not yet passed Congress, investors who are considering selling in the next few years may elect to do so now to take profits.

“Get it in motion today,” says John Chang, senior vice president and national director of research services at Marcus & Millichap.