By Chuck Sheldon, MBA
President, CEO, CCIM, CPM,
T & C Management
Congress is in the midst of debating tax reform, and of course changes to investing, capital gains, and real estate tax law is of great interest to us and the investors whose property we manage. On October 26, the NAA published comments on research being conducted about the value of like-kind exchanges, i.e. 1031s. For years there have been discussions about how 1031s should be handled – especially whether 1031 deferments should continue being allowed. This round of tax reform debate needs to be influenced by research recently released which confirms the validity of what the real estate world has continued to fight for.
Here is an excerpt of NAA’s comments:
As Congress continues to debate tax reform, NAA/NMHC have strongly argued for lawmakers to retain Like-Kind Exchanges in their current form as they incentivize investment and improve market values.
Reinforcing that message, a new study has found that the value of a like-kind exchange, as a percentage of the price of the replacement property, can be up to nearly 8 percent of property value. […] The research, conducted by Professors David Barker, David Ling and Milena Petrova demonstrates the key role that like-kind exchanges play in preserving property values.
Many proponents of repealing like-kind exchanges believe the Treasury would gain substantial revenue that could be used to pay for lower statutory tax rates in a tax reform package. The authors find, however, that “repeal (of like-kind exchanges) appears likely to generate less than $500 million per year to the Treasury.”
The math in favor of 1031 exchange deferment is simple and essential for lawmakers to understand.
If, for instance, you want to trade up your property and have $100,000, without 1031 deferments you have to anticipate paying approximately 30% in capital gains taxes on that $100,000. As such, you are forced to trade for a lower-value property in order to cover the taxes, slowing your growth and contributing to the stagnation of the real estate market. But if you have the opportunity to use a 1031 deferment, you will be able to invest the full $100,000 for trading up into a more valuable property, and wait on paying the capital gains tax. This allows your personal money to grow faster, the real estate market to gain momentum, and governments to have larger, higher-valued properties to tax.
Removing the 1031 deferment would not ultimately produce greater revenue for the Treasury, but merely a reduction in ease of growth for property investors and the real estate market at large. It appears that the new tax plan as presented by Republicans will be retaining 1031 deferments, which is a step in the right direction. Without them, the real estate market is likely to see a reduced speed of growth. It is important that we keep on top of this issue to ensure that 1031s remain fully intact for the good of the wider market and individual investors.