Capping 1031 Exchanges: The Juice Just Isn’t Worth the Squeeze

As Congress considers President Joe Biden’s $1.8 trillion American Families Plan, one proposed funding mechanism – a cap on 1031 like-kind real estate exchanges – would cripple commercial redevelopment at a critical time when our national economy needs that investment.

A $500,000 cap on 1031 exchanges — or for that matter at any amount – falls far short as a realistic “pay for” for even a portion of the plan. Consider that the president’s own estimates project a cap would raise $1.95 billion annually, while an Ernst and Young study projects that 1031 exchanges if left intact would produce nearly $5 billion a year in direct and indirect federal taxes alone.

One thing is clear – the juice just isn’t worth the squeeze!

For more than a century, like-kind exchanges authorized under Section 1031 of the Internal Revenue Code have allowed real estate owners to exchange their property for other income-producing properties and defer the tax on those gains. Typically, with the benefit of a tax deferral the new owner invests in substantial improvements to the acquired property, increasing its value and increasing tax revenue for local governments. When the property is eventually sold, the Federal Treasury is made whole in the full amount of deferred taxes.

Under a 1031 cap, the government gets its $1.95 billion of ‘juice’, but who gets squeezed?

Underserved communities. With the deferral of capital gains taxes, users of 1031 exchanges often leverage those dollars through investment in underserved communities. Investors are transforming outdated or distressed properties into beneficial uses such as building or renovating affordable housing or reinvigorating abandoned retail centers – activity which creates both temporary construction jobs and full-time permanent jobs in the community. Recent examples just in Chicago include bringing a grocery chain into a “food desert” neighborhood and the introduction of many national retail chains into South Side communities, but the same is happening in cities and suburbs across the nation through 1031.

Significantly, for many middle-class Black Americans, 1031 like-kind exchanges have presented new opportunities: the opportunity to plan for a comfortable retirement, the opportunity to create intergenerational wealth, the opportunity to grow business interests organically without overreliance on debt and the opportunity to reinvest in their communities.

Labor. Everybody would agree that a robust job market is important for creating pathways to growth throughout the nation. The Ernst and Young study indicates that 1031 exchanges for 2021, on a national basis, will support 568,000 jobs. This represents $27.5 billion in labor income and generates $5 billion in federal income taxes. Many of these jobs are created by capital investment into properties and employ trade unions representing electricians, carpenters, plumbers, contractors and masons.

Local tax coffers. Improved properties translate into greater property tax revenues for local governments, and a healthy commercial real estate market is a constant source of transfer taxes, mortgage taxes and recording fees for state and local municipalities. In fact, 1031 exchanges are projected to generate $2.8 billion in state and local taxes for 2021.

Commercial redevelopment. 1031 exchanges have always been a cornerstone of a healthy and vibrant commercial real estate market. An academic study confirmed that investors who leveraged 1031 exchanges made appreciably greater capital investment into their properties than those without an exchange.  It is dangerous and short-sighted then to believe that level of reinvestment would continue under a cap which would severely restrict the ability or willingness to redevelop commercial properties.

The national economy. A recent update to the E&Y study concluded that a cap or repeal of 1031 would shrink gross domestic product. If left intact? 1031 exchanges would grow the GDP by $55 billion in 2021.

When you add up the boost to the GDP, the jobs and labor income produced, the state and local taxes created and the federal taxes generated, 1031 exchanges are already delivering way more “juice” to the nation’s economy – without squeezing anybody.

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.

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