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Securities survey shows scrapping 1031 a danger to the economy

A fresh study has found that some six percent of all commercial real estate sales in the US use a 1031 tax exchange.

And deferred gains from real estate exchanges are associated with a relatively small static loss in Treasury revenues, according to the study by the Alternative & Direct Investment Securities Association.

The association co-sponsored The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate, which was presented on Capitol Hill in Washington, D.C.

The study focuses on the impact of Section 1031 exchanges and the negative effect of potential limitations on their use may have on the real estate sector were it to be repealed as part of a tax overhaul.

Section 1031 of the Internal Revenue Code states that “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”

Examining 1.6 million real estate transactions over an 18-year period, the report is authored by Professor David Ling, Ph.D., of the University of Florida, and Assistant Professor of Finance Milena Petrova, Ph.D., of Syracuse University.

“ADISA believes that Section 1031 exchanges are a vital investment tool and we couldn’t be more pleased with the results of this cutting-edge study,” said John Harrison, chief executive officer and executive director of ADISA.

“Its findings provide numerical evidence of the positive effects Section 1031 exchanges have on the national economy, and real estate investments overall.”

According to Ling and Petrova, eliminating real estate exchanges in markets where marginal investors expect to use an exchange, commercial real estate prices will decline between 8 percent and 17 percent in markets with moderate taxes, and between 22 percent and 27 percent in high tax states and markets.

Rent increases are estimated at approximately eight percent to 20 percent in moderately taxed markets, and between 28 percent and 38 percent in highly taxed markets.

Real estate exchanges were found to be associated with increased investment, reduced leverage and short holding periods.

The congressional briefing presentation established that:

  • Replacement like-kind exchanges are correlated with an investment that is approximately $305,000 greater, 33 percent of value, than acquisitions by the same investor following a sale of a property.
  • Capital expenditures, specifically building improvements, in replacement exchange properties tend to be higher by about $0.27 per square foot to $0.40 per square foot.
  • Investors in like-kind exchanges use 6 percent less leverage when compared to ordinary acquisitions.
  • Holding periods for properties acquired through 1031 exchanges are, on average, six months shorter.

Finally, the study found that most exchange replacement properties are subsequently sold in fully taxable sales.

The authors stated that “in 88 percent of our sample, investors disposed of properties acquired in a 1031 exchange through a fully taxable sale. The estimated taxes paid in an exchange followed by a taxable sale versus an ordinary sale are on average 19 percent higher.”

The Alternative & Direct Investment Securities Association is the leading trade association serving alternative investment and securities industry professionals who are active in offering, managing and distributing private and public direct investments.

ADISA connects members directly to key industry experts through intimate forums and leading edge conferences and trade shows providing timely trends and education. The association was founded in 2003 and has more than 4,000 members who are key decision makers that represent over 30,000 professionals throughout the nation. ADISA works to maintain the integrity and reputation of the industry by promoting the highest ethical standards and providing education and resources to its members.

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