Written by Darius Assemi and Daniel Wagner
You likely don’t realize it, but an essential tool in rebuilding our American economy is at serious risk as part of the $1.8 trillion American Families Plan being considered in Washington.
And if this flaw isn’t addressed, the damage will be felt in every state, city, and town still reeling from the ravages of COVID-19.
The plan proposes to cap the financial gains that can be deferred in a 1031 like-kind real estate exchange at $500,000.
The term “1031 like-kind exchange” sounds like something that only concerns investors. But it’s a part of the tax code that benefits virtually every American. This provision promotes job growth, makes affordable housing possible, and helps create conservation easements benefiting wildlife and the environment. In short, 1031 keeps our economy humming while helping address some of America’s most pressing problems.
Unfortunately, this proposed cap is a recipe for economic stagnation —not recovery— and would shrink net tax revenue. A 2017 macroeconomic study by Ernst & Young, recently updated, concluded that if section 1031 were limited or repealed, it would shrink GDP.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 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 generated from jobs in one year far exceeds the estimate in the 2021 Biden budget that says capping 1031 at $500,000 raises an average of $1.95 billion per year over 10 years.
Clearly, this proposal doesn’t make economic sense for taxpayers or the economy.
Some argue that the provision is a “loophole” used to avoid taxes on gains. But, the truth is, a 1031 exchange is a deferral, not an elimination. Taxes are paid over a 15-year window. According to a 2020 study, 80% of taxpayers do only one 1031 exchange and then dispose of the property in a taxable sale.
For the last 100 years, 1031 like-kind exchanges 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. This tool supports job growth, the health of U.S. commercial real estate, and the growth and preservation of family-owned businesses — including farms, ranches, and forestland.
Like-kind exchanges increase the supply of affordable rental housing by filling gaps in housing supply not covered by other incentives. And, when gains are reinvested in new property through an exchange, they create a ladder of economic opportunity for small and minority-owned businesses and entrepreneurs while generating much-needed tax revenue for states and localities.
In the Central Valley, the $500,000 cap would devastate affordable housing, conservation easements, and commercial real estate. That’s because 30% to 40% of all agricultural transactions in California are made possible by a 1031 exchange. Thus, with farmland in the Central Valley selling for $40,000 per acre, a cap would effectively eliminate 1031 like-kind exchanges for farms and conservation easements.
Section 1031 also provides critical capital for affordable housing. Roughly 50% of all exchange transactions involve housing, both single-unit rentals and multifamily. Professors David C. Ling of the University of Florida, and Milena Petrova of Syracuse University examined 1.6 million transactions nationwide. They concluded that if section 1031 is capped or repealed, transactions will significantly slow down and the price of real estate will rise — as will rents and interest rates.
In commercial real estate, 1031 exchanges touch 20% or more of all transactions in California. As most transactions are significantly higher than $500,000, the cap will impede the redevelopment of aging shopping malls, strip centers, hotels, and office buildings. The inevitable result: more graffiti-riddled eyesores attracting criminal activity.
As you can see, the case against this proposed 1031 cap is overwhelming. Our hope is that Congress will fix this flaw in the American Families Plan before it stops our nation’s comeback in its tracks.
Darius Assemi of Fresno is president and CEO of Granville Homes, a real estate development company established in 1977 which has been involved in the acquisition, development, financing of more than 100 projects. Daniel Wagner of Oak Brook, Illinois, is senior vice president of government relations for The Inland Real Estate Group of Companies and past president of the Chicago Association of REALTORS®.