Study: 1031 Repeal Would Do Little Good, Much Harm

WASHINGTON, DC—Released shortly after a National Association of Realtors survey of its members that extolled the benefits of like-kind exchanges, a new study makes an even stronger case for these transactions. Cosponsored by the Alternative & Direct Investment Securities Association, the study finds that 1031 exchanges provide economic benefits that outweigh the deferment of tax revenues.

Titled “"The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate," the study was prompted by recent Congressional proposals to repeal or curtail 1031 exchanges across the commercial real estate sector. The study's authors, Drs. David Ling of the University of Florida and Milena Petrova of Syracuse University, see no good coming from a repeal.

"The elimination of real estate exchanges will likely lead to a decrease in prices in the short-run, followed by an increase in rents in the longer run,” Ling and Petrova write. “These negative effects will be more pronounced in high-tax states.”

Ling and Petrova studied 1.6 million real estate transactions conducted over an 18-year period. They found that 6% percent of all commercial real estate sales, based on dollar volume and number of transactions, utilize deferments of capital gains and ordinary income taxes as allowed under Section 1031 of the Internal Revenue Code. For high-tax states, the use of 1031 exchanges was reported to vary between 10% and 18% of all sales in those states; Ling and Petrova wrote that the percentages likely were understated.

The study shows that deferred gains from real estate exchanges are associated with a relatively small static loss in Treasury revenues—which are then more than made up on the back end. Governments collect 19% more taxes on commercial properties sold following a like-kind exchange than by an ordinary sale, while 88% of commercial properties acquired by a like-kind exchange result in a taxable sale in the next transaction, according to Ling and Petrova.

Industry leaders lauded the study. “The new Ling-Petrova study demonstrates how critical like-kind exchanges are to the health and vibrancy of real estate activity in the United States,” says Jeffrey DeBoer, president and CEO of the Real Estate Roundtable.  “Acquiring and improving commercial real estate requires large amounts of capital, and section 1031 helps real estate businesses grow and expand organically—with less debt. In short, like-kind exchanges allow property owners to put more of their earnings back into the private sector: hiring workers, upgrading and improving properties, and generating much-needed economic activity.”

Armed with the Ling/Petrova study, ADISA CEO John Harrison and other Roundtable members met with Congressional staff this past Friday. Industry representatives briefed lawmakers' staff on how real estate like-kind exchanges function, who uses them and why and how prevalent these exchanges are throughout the country.

“We need at least 300,000 new apartments every year, and the multifamily industry cannot build without outside investment,” says Doug Bibby, president and CEO of the National Multifamily Housing Council. The release of the Ling/Petrova study, he adds, “solidifies just how important 1031 exchanges are in meeting the exploding demand for rental housing.”