Viewpoint: Danger lurks in Biden plan to eliminate or cap 1031s
By Philip J. McGinnis & 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 the COVID-19 pandemic, which shuttered countless shopping malls, retail centers and restaurants. The fallout continues with hotels and office buildings as virtual meetings are replacing business travel, and many people continue to work from home exclusively.
As every state in the nation – Delaware especially – begins to creep toward economic rebound, commercial real estate must again play an essential role in our recovery. But the Biden plan to eliminate the deferral of taxes on property gains over $500,000 from like-kind exchanges, granted under Internal Revenue Code Section 1031, 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 Delaware and grow our economy. It has been used to provide affordable multifamily housing in working class communities, reimagine commercial shopping centers, and allow growing businesses to expand their space. These transactions are in the millions of dollars. The cap will significantly hurt in these areas.
The Federation of Exchange Accommodators, the national organization of 1031 Exchange companies, analyzed the data from six companies in Delaware between 2015-2019 and found:
- There were 587 properties involved in exchanges;
- Those transactions generated $55.7 million in state and county transfer taxes and recording fees across the state.
Actual 1031 activity in the state is far greater, as many companies facilitate exchanges. It is estimated that 15% to 20% of commercial transactions involve a 1031. It is clear Section 1031 is important to our region’s economy and generates significant tax revenue.
A common misconception fueling attempts to remove 1031 exchanges is that they are a loophole to avoid paying taxes. That is not the case. A microeconomic study on 1.6 million properties 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 the deferred taxes paid within roughly a 15-year window.
Additionally, a 2017 macroeconomic study by Ernst & Young, recently updated, concluded that if section 1031 were limited or repealed, it would shrink gross domestic product by a whopping $9.3 billion per year.
The study further projected benefits from 1031 exchanges for 2021 and concluded that, on a national basis, these transactions will:
- support 568,000 jobs, representing $27.5 billion in labor income and generating $5 billion in federal income taxes;
- generate $6 billion annually in federal taxes from foregone depreciation on replacement properties;
- generate $2.8 billion in state and local taxes;
- add $55 billion to the GDP.
Just the $5 billion in federal taxes from jobs in one year far exceeds the 2021 Biden budget estimate of $1.95 billion per year over 10 years coming from a $500,000 cap on 1031 exchanges. Why change Section 1031? It doesn’t raise any money.
Capping 1031 exchanges – which serve as an essential generator of economic redevelopment, support jobs, and produce tax revenue for local governments here in Delaware and across the nation – 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, cities, and American families who have struggled mightily from the ravages of the pandemic.
Philip J. McGinnis is the managing broker of McGinnis Commercial Real Estate Company and former chair of the Delaware Council on Real Estate Appraisers. Daniel Wagner is senior vice president of government relations for The Inland Real Estate Group of Companies and past president of the Chicago Association of Realtors.