Danger Lurking in Biden Plan to Eliminate or Cap 1031s

Linda Gerchick and Daniel Wagner

The strength and resilience of the commercial real estate market has been tested many times over the last 100 years – never more so than during these past 16 months as the COVID-19 pandemic shuttered countless retail centers, restaurants, hotels and office buildings.  The fallout continues. It is estimated that up to 25% of the strip shopping centers will go bankrupt.  Virtual meetings will permanently replace significant business travel, and many people will work from home exclusively. 

As every state in the nation, Arizona especially, begins to creep towards an economic rebound, commercial real estate must again play an essential role in that recovery. The Biden plan to eliminate the ability to defer taxes on property gains over $500,000 from like-kind exchanges of real estate, which is granted under Section 1031 of the Internal Revenue Code, will cripple commercial redevelopment at a time when our communities need that investment more than ever.

Section 1031 provides important capital to revitalize communities throughout the Phoenix area and grow our economy. It has been used to provide affordable multifamily housing in working class communities, revitalize commercial shopping centers and allow growing businesses to expand their space.

The Federation of Accommodators, the national organization of 1031 Exchange companies, analyzed and aggregated the data for the State of Arizona from seven companies in Arizona from 2015 to 2019 and found there were 14,000 properties involved in exchanges with a total value of $23.4 billion.

This is just a portion of the Arizona market as there are many more companies that facilitate exchanges, but it is clear that Section 1031 is important to the real estate economy and that it generates significant tax revenue for state and local governments.

An all-too-common misconception, and one which has often fueled attempts to remove the provision, is that 1031 exchanges are a loophole to avoid the payment of taxes.  That is not the case.  A microeconomic study on 1.6 million properties conducted by professors David C. Ling (Univ. of Fla.) and Milena Petrova (Syracuse Univ.) concluded that 80% of replacement properties acquired in a 1031 exchange were ultimately disposed of through a taxable sale, rather than a subsequent exchange, with all of the deferred taxes getting paid within roughly a 15-year window.

 

Additionally, a macroeconomic study initiated by Ernst & Young in 2017, and recently updated, concluded that if section 1031 were limited or repealed, it would shrink GDP by a whopping $9.3 billion per year.  It further examined the potential benefits from the use of 1031 exchanges for the coming year and concluded that transactions from section 1031 exchanges will create an estimated 568,000 new jobs (260,000 in businesses using 1031, and another 308,000 from suppliers to those businesses), generating $27.5 billion in labor income which in turn will generate $55 billion value added to the GDP, and $14 billion paid in federal, state and local taxes. That $14 billion 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.   Why would anyone change Section 1031?  It doesn’t raise any money.

Clearly the benefits gained by the national – as well as local – economies from 1031 exchanges far exceed the assumed cost to the Treasury from these temporary tax deferrals – with ‘deferral’ being the operative word.

In the end, the Treasury receives its money; state and local entities enjoy the annual increased taxes generated by the healthy redevelopment of commercial property; and the local and regional economy is strengthened through the creation and retention of jobs.

Eliminating or capping 1031 exchanges – which serve as an essential generator of economic redevelopment, jobs, and local tax revenue for Phoenix and other cities and counties across Arizona – would fall far short as an expected source to pay for the American Families Plan, and ultimately have the unintended consequence of harming, not helping, our towns, our cities, and our American families who have struggled mightily from the ravages of the pandemic.

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Linda Gerchick, CCIM a specialist in income producing properties, owns Gerchick Real Estate in Scottsdale. She is a repeat recipient of the Phoenix Board of Realtor’s Presidential Award.

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®.

 

 

With the vaccine rollout ahead of schedule and the economy recovering, 2021 brings us a renewed sense of opportunity. But we all remain diligent: with tremendous activity in the marketplace and historically low interest rates, we need to constantly stay in touch with the forces  that shape our market. My unmatched research abilities and cutting-edge technology keep me consistently tuned into the pulse of the marketplace. There has never been a better time to connect with me and let help you realize your investment vision.

Remember that my trademarked tagline is “Make the market work for You!”

I have added some personal thoughts and at the bottom is some key information from one of my referral partners, Tom Bonetto.  He is the lending coach for one to four units.

Balancing your life is one of the hardest items that I think that any of us encounter.  I wanted to share my thoughts on this. Anyone that knows me either on a business level or on a personal level knows that I am passionate in everything that I do. 

When I had covid-I closed three deals while in the hospital and I was critically ill.  One of my clients said afterwards, “Of course, you did!”.

Yesterday, I had a client call that I haven’t spoken to in over a decade and he said, I know how you work and how you are.  I am now bringing to market several of his multifamily which I sold to him these many years ago.

Here are my foundations:

  1. A loving atmosphere in my home is the foundation of my life!
  2. If in a disagreement with loved ones, deal only with the present not the past
  3. Share my knowledge, everyone knows that I love to teach!
  4. Be gentle with the Earth-she loves us
  5. Remember that the best relationships are the ones that your love for each other exceeds your need for each other!
  6. Judge your success by what you had to give up in order to achieve it.
  7. Approach love and cooking with the same reckless abandon.

Here are the thoughts from Tom Bonetto on investing with 1-4 units as well as some information about basis points. DON’T FORGET TO REGISTER ON THE WWW.JUSTSOLDIT.COM WEBSITE, I HAVE A GREAT GLOSSARY ON THE BACKSIDE AND IT IS GREAT. 

I’d invite you take a look at the “March 2021 Mortgage Rate and Market Update” for the specifics on what is happening regarding rates for 2nd homes and investment properties: 

https://lendingcoach.net/march-2021-mortgage-rate-and-market-update/ 

Fannie Mae and Freddie Mac are tightening the underwriting criteria for second homes and investment properties, the government sponsored entity said last Wednesday.  

“Recent amendments to our senior preferred stock purchase agreement with Treasury impose additional risk criteria on the loans we acquire,” the GSE said in a letter. “One of those restrictions is a 7% limit on our acquisition of single-family mortgage loans secured by second home and investment properties.”

This means that non-owner occupied transactions (2nd homes and investment properties) will become a bit more difficult in terms of qualification and slightly more expensive, in terms of interest rates. 

Lenders are now being forced to add to the cost of the loan and raise interest rates – anywhere from .50 basis points to as high as 250 bps.  That can mean an increase in rate of 1/8% to 1.25%, depending on the investor. 

Finance of America, my employer, has added .50 basis points for all 2nd home and investment property purchases, which is on the low side, relative to many in the industry.  Others that I’ve spoken to have added as much as 250 bps.

 

From Investopedia: “Basis points, otherwise known as bps, are a unit of measure used in finance to describe the percentage change in the value of financial instruments or the rate change in an index or other benchmark. One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form.” 

Don’t hesitate to contact me for more information: 

Tom Bonetto, The Lending Coach – NMLS#1431961

480-788-2658

tom@lendingcoach.net

https://lendingcoach.net

Have a great day and remember that I answer my phone  602-688-9279.

Linda