New Study Confirms Like-Kind Exchanges Encourage Job Creation and Stimulate Economic Growth

A new, in-depth study of the U.S. commercial real estate market found that 1031 like-kind exchanges strengthen the market and stimulate job creation, investment, and economic growth.

“The Economic Impact of Repealing or Limiting Section 1031 Refers to the "nature or character" of the property and not to its "grade or quality." That is, real property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other real property. Personal property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other personal property, provided the personal property is of "like kind" or "like class." Professional tax advice should be obtained when planning exchanges. Like-Kind Exchanges in Real Estate” analyzed more than 1.6 million real estate transactions over an 18-year period. It was commissioned by the Real Estate Refers to the "nature or character" of the property and not to its "grade or quality." That is, real property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other real property. Personal property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other personal property, provided the personal property is of "like kind" or "like class." Professional tax advice should be obtained when planning exchanges. Like-Kind Exchange Coalition, comprised of organizations across all sectors of the industry, in response to legislative proposals to repeal Section 1031.

Read an overview of the Ling-Petrova Study at the FEA's website.

Study Findings:

• Like-kind exchanges encourage investment.  On average, taxpayers using a like-kind exchange acquire replacement property that is $305K-$422K more valuable than the relinquished property, while replacement properties without using an exchange are cheaper or of equal value.
• Like-kind exchanges contribute significant federal tax revenue.  In 34 percent of exchanges, some federal tax is paid in the year of the exchange. More importantly, over the long run, like-kind exchanges boost tax revenue because of the higher tax liability that arises in the years following the initial exchange.
• Like-kind exchanges lead to job creation.  Real estate acquired through a like-kind exchange is associated with greater investment and capital expenditures (i.e., job-creating property upgrades and improvements) than real estate acquired without the use of like-kind exchange.
• Like-kind exchanges result in less debt.  When the price of the replacement property is close to, or less, than the price of the relinquished property, like-kind exchanges result in a 10 percent reduction in borrowing, or leverage, at the time of the acquisition.

Additionally, in response to legislative proposals to eliminate like-kind exchanges, the study found that such action would have the following deleterious effects:

• Taxes would increase for thousands of commercial property owners.  For a typical property owner who defers his or her gain on a commercial property, repealing like-kind exchanges would raise the effective tax rate on the taxpayer’s investment (including rental income and gain; nine-year holding period) from 23 percent to 30 percent.
• Property values would drop.  In order for a commercial property to generate the same rate of return for the investor (if section 1031 were repealed), prices would have to decline. In local markets and states with moderate levels of taxation, commercial property price would have to decline 8 to 12 percent to maintain required equity returns for investors expecting to use like-kind exchanges when disposing of properties. These price declines would reduce the wealth of a large cross-section of households and slow or stop construction in many local markets.
• Rents would increase.  Over time, real rents would need to increase from 8 to 13 percent before new construction would be economically viable.  These higher rents would reduce the affordability of commercial space for both large and small tenants. The price declines and rent effects of eliminating real estate like-kind exchanges would be more pronounced in high-tax states.
• Real estate sales activity would decline.  Like-kind exchanges increase the liquidity of the real estate market.  An analysis of 336,572 properties that were acquired and sold between 1997 and 2014 showed that properties involved in like-kind exchanges had significantly shorter holding periods.

The study’s authors, Dr. David Ling (finance professor at the University of Florida’s Warrington College of Business and past president of the American Real Estate and Urban Economics Association) and Dr. Milena Petrova (finance professor at Syracuse University’s Whitman School of Management), analyzed more than 1.6 million real estate transactions over an 18-year period (1997 – 2014).  Combined, the total volume of the transactions (unadjusted for inflation) is $4.8 trillion.

“The Economic Impact of Repealing or Limiting Section 1031 Refers to the "nature or character" of the property and not to its "grade or quality." That is, real property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other real property. Personal property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other personal property, provided the personal property is of "like kind" or "like class." Professional tax advice should be obtained when planning exchanges. Like-Kind Exchanges in Real Estate” was developed using the most comprehensive database of US commercial real estate activity in existence.