Critics: Limit on tax-free property exchanges could backfire
Real estate investment would go stagnant, commercial property go unimproved, and construction jobs go away if President Joe Biden succeeds in chopping the popular tax accounting regulation known as a 1031 tax-free exchange, some real estate specialists say.
“It could freeze the market,” said Ford Price, managing partner of Oklahoma City brokerage Price Edwards & Co.
Section 1031 of the Internal Revenue Code encourages investment by
letting sellers postpone paying capital gains taxes through a series of exchanges. Taxes only come due when there is a sale not followed by another purchase — without reinvestment.
Biden wants to end the tax break for gains greater than $500,000 as part of his American Families Plan. It’s part of his broader plan to finance child and elder care.
The White House says it’s part of the president’s plan to “eliminate long-standing loopholes” and “ensure that high-income Americans pay the tax they owe under the law.”
It would end “the unfair system of enforcement that collects almost all taxes due on wages, while regularly collecting a smaller share of business and capital income,” the White House says.
But critics say capping 1031 at $500,000 would go against the president’s goals for job creation and be a drag on the economy.
The proposal is based on a “misguided view of the actual purpose and benefits” of deferring taxes on property sales, according to the Federation of Exchange Accommodators.
Section 1031 “is a powerful stimulator of the U.S. economy,” the trade group says, and “is not an unfair or abusive loophole. It is broadly used by taxpayers ranging from middle class individuals exchanging rental houses and small apartment buildings, farmers, and small to mid-sized businesses, to larger taxpayers exchanging large commercial properties in major metropolitan areas.”
The common investment tool has helped spur development in the Oklahoma City metro.
The office building One Benham Place, retail-office center 50 Penn Place, Mayfair Village Shopping Center, Market Place Shopping Center in Edmond, and Oak Hollow addition at Memorial and Coltrane roads are among metro-area properties involved in tax-free exchanges over the years.
More recently, Sprouts Farmers Market-anchored Greenbriar Square Shopping Center changed hands in a 1031 exchange handled by Will Lightfoot, a partner and investment sales specialist with Shop Cos., a brokerage with offices here, in Dallas and Houston. The tax break saves investors billions of dollars, but not just the rich, and limiting it won’t yield as much tax revenue as proponents seem to think it will, Lightfoot said.
“There is a perception that these savings all go to the wealthy, and that it will
now translate into the same amount of tax dollars,” he said. “However, this will affect property investors at every level, and the lowered values and slowed velocity of transactions will eat away the (expected) tax revenue.”
Price said individuals and smaller investor groups would be hit hardest.
“The large commercial real estate investors and REITs (real estate investment trusts) will not be nearly as impacted as the small investor,” he said. “Very hard to make the math work if every time an individual investor sells a property 40% to 50% of your gain goes to taxes. It’s not worth the risk inherent in the commercial real estate business.”
Section 1031 actually creates income tax revenue even as it defers payment of capital gains taxes, said Mark Inman, senior vice president and retail broker with CBRE in Oklahoma City. Inman recently brokered a 1031 deal involving 12 acres at Northwest Expressway and Kilpatrick Turnpike.
Knowing capital gains would be taxed, “Sellers would no longer be incentivized to sell and reinvest,” Inman said. There would be other repercussions
as well, according to Inman. “These transactions are also sources of jobs for contractors, skilled and unskilled blue collar workers, lenders, real estate brokers, title insurers, escrow companies, surveyors, appraisers, architects, landscapers, and building material suppliers,” he said.
Price said it would shrink the construction/renovation business “as many times the newly acquired property needs capital improvement dollars spent on it to reposition in the marketplace.”
It would discourage redevelopment and renovation of older buildings, leaving more buildings “sitting underutilized and underinvested,” Lightfoot said. “EY (Big Four accounting firm Ernst & Young) says that 1031 exchanges support an estimated 568,000 jobs, generating over $55 billion annually, in addition to $27.5 billion in labor income.”
If investment sales dried up, it would cut into property valuations and taxes that go to support public schools and county services, Oklahoma County Assessor Larry Stein said.
When a sale occurs, assessors reassess the property, usually for significant property tax increases. Without a sale, or major improvements, assessors in Oklahoma are constitutionally limited to a yearly capped tax increase.
“I think we would have a lot of investors that would sit on those properties
and not take risks and opportunities,”
Stein said.
Real Estate Editor Richard Mize edits The Oklahoman’s Real Estate section, and covers housing, construction, commercial real estate, and related topics for the newspaper and Oklahoman.com. Contact him at rmize@oklahoman.com. Please support his work and that of other Oklahoman journalists by purchasing a subscription, http://subscribe.oklahoman.com.