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®.