“The Tax And Economic Impacts Of Section 1031 Like-Kind Exchanges In Real Estate”
PROF. DAVID C. LING, PHD, UNIVERSITY OF FLORIDA
PROF. MILENA PETROVA, PHD, SYRACUSE UNIVERSITY
Submitted to the Real Estate Research Consortium
Published: October, 2020
A microeconomic study focused on Section 1031 like-kind-exchanges within commercial real estate. The 2020 study, “The Tax and Economic Impacts of Section 1031 Like-Kind Exchanges in Real Estate” focuses on the period from 2010 to June 2020 and provides a comprehensive view of the use and geographic distribution of IRC Section 1031 like-kind exchanges. The authors examined data from CoStar, the National Association of Realtors, Marcus & Millichap Research Services and Investment Property Exchange Services (“IPX1031®”). This research updates a 2015 study by the same authors examining the impact of a repeal of Section 1031.
The updated research concludes that exchanges spur capital expenditures, increase investment, create jobs for skilled tradesmen and others, reduce economic risk, lower rents, support property values, and generate substantial state and local tax revenue.
HIGHLIGHTS & KEY FINDINGS
- Like-kind exchanges are important to a healthy, liquid real estate market
- 10-20% of all commercial real estate (CRE) transactions involve Section 1031 exchanges
- 38% of all CRE exchanges involve multi-family housing
- Like-kind exchanges preserve capital & encourage capital improvements which:
- Create jobs;
- Add to state & local tax bases.
- Greater investment– Section 1031 Buyers invest significantly more capital (15.4%) into Replacement Properties than non-1031 Buyers
- Exchange acquisitions are associated with:
- Greater equity & lower leverage – 30% loan to value (LTV) for 1031 replacement properties compared to 43% for non-1031 acquisitions
- Reduced credit risk for investors and lenders.
- Like-kind exchanges encourage shorter holding periods and improve marketability of illiquid commercial real estate
- Nationally, half of all exchanges valued above $575,000
- The vast majority of Section 1031 exchanges are one-time events, followed by taxable sale
- Less than 20% of replacement properties are disposed of in a subsequent exchange
- Elimination of Section 1031 would cause a decrease in:
- Transaction activity,
- Capital investment, and
- Real estate prices.
- Real estate prices would decline by approximately 6%
- Elimination of Section 1031 would cause an increase in:
- Holding periods,
- The cost of capital,
- Leverage, and
- Rents would increase by approximately 6%
- At least 1/3 of all like-kind exchanges are partially taxable in the year of the exchange
- The JCT tax expenditure estimate is overstated
- The incremental value of an exchange strategy as a percent of the deferred tax liability ranges from a low of 8 percent to a high of 58 percent with a mean of 37 percent. Said differently, 63 percent of the value of immediate tax deferral is eliminated by reduced depreciation deductions in the replacement property and increased capital gain and depreciation recapture taxes.
DOWNLOAD NEWEST STUDY (2020)
Full Report: “The Tax and Economic Impacts of Section 1031 Like-Kind Exchanges in Real Estate”
Ling & Petrova, 2015 Microeconomic study, “The Economic Impact Of Repealing Or Limiting Section 1031 Like-Kind Exchanges In Real Estate”
Presentation: Milena Petrova, Economic Impact of LKE in Real Estate, 2021
Video: Congressional Briefing, LKE Economic Impact Studies, 5-27-2021