The law of unintended consequences looms over a potential seismic change in commercial real estate.
The strength and resilience of the commercial real estate market has been tested many times over the past 100 years — never more so than during the pandemic, which shuttered hundreds of 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, Florida especially, begins to creep toward an economic rebound, commercial real estate must again play an essential role in the recovery. The Biden Administration 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 the state — from the Gulf Coast through Orlando to the eastern shores — and grow our economy. It has been used to provide affordable multifamily housing in working class communities, revitalize commercial shopping centers and allow growing businesses to expand their space.
The Federation of Accommodators, the national organization of 1031 Exchange companies, analyzed and aggregated the data for Florida from eight companies from 2015 to 2019 and found:
• At least 20,206 properties were involved in 1031 exchanges.
• The total value of those properties was $40 billion.
• Deals through 1031 rules generated $395 million in state and county transfer taxes and recording fees
Actual 1031 activity in Florida 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 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. (1031taxreform.com/ling-petrova/)
Additionally, a 2017 macroeconomic study by Ernst & Young, recently updated, concluded that if section 1031 were limited or repealed, it would shrink GDP by a whopping $9.3 billion per year. (1031taxreform.com/1031economics/)
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 Administration budget estimate of $1.95 billion per year over 10 years coming from a $500,000 cap on 1031 exchanges.
So 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 the Gulf Coast and nationwide — 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.
Ray Turchi is Senior Vice President Investments with Marcus & Millichap in Orlando. Daniel Wagner is Senior Vice President of Government Relations for The Inland Real Estate Group of Companies.