When President Joe Biden released his $ 1.8 trillion American Family Plan in April, he proposed paying the increased federal spending by capping the deferral amount for exchanges of a similar nature under Internal Revenue Code Section 1031 to $ 500,000 .
According to the president's own numbers, the proposed cap would bring in $ 2 billion a year for the Treasury Department. The problem is that the change would cost the government more than it would save. A recent study by Ernst and Young estimates that the current provision of similar foreign exchange generates nearly $ 5 billion annually in direct and indirect federal taxes, along with billions of dollars in state and local taxes.
And it's not just the federal government's bottom line that would be affected by a 1031 tax deferral cap. When you consider how 1031s are used to help communities and individuals, it's clear the juice isn't worth the pressure.
For 100 years, similar exchanges have enabled property owners to swap their property for other income and defer tax on any unrealized gains. If the owner eventually liquidates the investment, the government will levy taxes on the profits. If the owner eventually liquidates the investment, the government will levy taxes on the profits. Often times, the value of the new property rises above the original investment, which leads to increased tax revenues for the state. While there are rules about the time frame in which an exchange must be completed, there is no upper limit to the amount a property owner can postpone using this tax strategy.
Investing in Underserved Communities
By enabling property owners to channel profits into new property investments, the sharing of similar types serves as a critical component in attracting development funds and bringing prosperity to underserved communities.
The additional capital saved by not paying the tax immediately could revitalize an abandoned shopping district or unused warehouse and allow owners to turn obsolete properties into more productive uses, such as affordable housing for workers or an e-commerce store. Hub that creates jobs. A 2020 study by David Ling of the University of Florida and Milena Petrova of Syracuse University confirmed that the like-for-like exchange generated significantly higher capital investments in real estate than those purchased without the exchange.
“While the black community is looking for ways to grow their financial resources. . . the exchange of 1031 similar types is more important than ever, ”said Norman Alexander, president of the Ridgecrest Area Association of REALTORS® in Ridgecrest, California and a member of the California Association of Black Real Estate Professionals.
David Doig, President and CEO of Chicago Neighborhood Initiatives, brought a national grocery chain, Kroger & # 39; s, to a former food wasteland in the Bronzeville neighborhood of the city's South Side. The site, formerly the demolished Ida B. Wells social housing complex, had remained empty for over 15 years. In his place, Doig's company developed a Mariano supermarket, and then a New York investment group bought the new development through a 1031-like exchange. This borrowed capital brought jobs, housing and commerce to the community.
"We need to keep the similar type of exchange from 1031 because it is another tool to encourage private capital to flow into commercial real estate projects that will help revitalize our underserved communities," said Leon Walker, President and CEO of DL3 Realty and the developer who brought Whole Foods, Starbucks and Chipotle to Chicago's South Side Englewood Community.
Investment in job creation, retirement income
Jobs. Jobs. Jobs. Everyone on the political spectrum agrees that a robust labor market is important in order to pave the way for economic growth. Studies show that a similar exchange in a community has a multiplier effect when it comes to creating and maintaining jobs. Ernst and Young's study concludes that if Section 1031 were to be restricted or eliminated, real estate transactions would decrease, the cost of capital would increase and gross domestic product would shrink. The study found that under applicable law, 1,031 exchanges generate $ 4.4 billion in additional investment and secure 568,000 jobs each year. That equates to a labor income of $ 27.5 billion in 2021. Much of these jobs come from capital improvements made to real estate after a similar exchange, creating jobs for electricians, carpenters, plumbers, builders, bricklayers and building materials suppliers will .
“Every time we sell an apartment complex, we use the 1031; if it were not available, we would not be able to complete this transaction, ”said Bill Brown, 2017 President of the National Association of REALTORS® and owner of Springhill Real Estate Partners. Brown's San Francisco Bay Area company invests in apartment buildings in cities like Boise, Idaho; Portland, Ore .; and phoenix.
"My company spends between $ 7,000 and $ 10,000 per unit on the remodel," says Brown. “This helps to create jobs for workers as well as materials such as carpets, cupboards and many other goods.” Such modernizations not only create jobs, but also improve the quality of life for the tenants in the apartments.
"Our local IBEW is very involved in economic development," says Frank Furco, director of the International Brotherhood of Electrical Workers Local 701 in Warrensville, Illinois members. "
And jobs are not the only reason unions support 1,031 similar exchanges. Section 1031 transactions are important to real estate investment trusts and hence the annuity and 401 (k) plans investing in REITs. In particular, Section 1031 enables a REIT to effectively manage its real estate portfolio and trade real estate to manage risk and maximize returns. This benefits both working and retired Americans who own REIT stocks in their retirement funds – especially unions like IBEW 701, which fund their own pensions. Union members often work and live in the same communities that benefit from the economic expansion made possible by exchanges of a similar nature.
