A study co-sponsored by the Alternative & Direct Investment Securities Association (ADISA), a trade association for the alternative and direct investment space, has found that the elimination of Section 1031 exchanges would disrupt many local property markets, harm both tenants and owners as well as hurt small investors.
The study, The Tax and Economic Impacts of Section 1031 Like-Kind Exchanges in Real Estate, was conducted by David Ling, Ph.D., a professor at the University of Florida, and Milena Petrova, Ph.D., an associate professor at Syracuse University.
The study also concludes that the elimination of real estate related like-kind exchange would likely lead to a decrease in commercial real estate prices in many markets, less reinvestment in commercial and residential real estate, a greater use of leverage to finance acquisitions, and an increase in investment holding periods that would result in a decrease in market liquidity and a slowdown in related industries.
“ADISA is a strong and continuous advocate for Section 1031 exchanges, a vital tool that functions to increase investment and acts to stimulate the overall economy,” said John Harrison, executive director at ADISA. “Because of their complexity, Section 1031 exchanges are often misunderstood. Many have always believed in the strength and benefit of Section 1031 exchanges, but studies like the new one from Ling and Petrova…work to prove the value through statistical data. And this data shows how the elimination of like-kind exchanges would have a widespread and substantial effect on the real estate market.”
As part of the study, the authors analyzed CoStar data from approximately 816,000 property transactions that took place in 880 core-based statistical areas from January 1, 2010 until June 30, 2020, with a median price of $1.1 million and a total transaction volume of $3.4 trillion.
Additionally, they reviewed Marcus & Millichap Research services data on the share of exchanges via property type and asset class in transactions that took place from 2017 to 2019, and also corroborated with a July 2020 survey by the National Association of Realtors. The authors also took into account exchange data from Investment Property Exchange Services Inc.
Of the commercial real estate transactions that took place between January 1, 2020 and June 30, 2020, Section 1031 exchanges likely made up 10 percent to 20 percent of the share of those sales.
The median sale price of a property involved in an exchange in 2018 and 2019 equaled approximately $500,000, demonstrating that 1031 exchanges are not primarily used by large institutional investors, but utilized across a range of taxpayer types, income levels and property values.
Approximately 63 percent of the value of immediate tax deferral is eliminated by reduced depreciation deductions in the replacement property as well as increased capital gain and depreciation recapture taxes.
The authors also conclude that if like-kind exchanges were eliminated, there would be little additional tax revenue generated, a potential for upward pressure on real estate-related rents in the long-run, and a potential secondary effect that might include decreased employment in real estate and related sectors.
The Alternative & Direct Investment Securities Association bills itself as the nation’s largest trade association representing the non‐traded alternative investment space. Its members are typically involved in non-traded real estate investment trusts, business development companies, master limited partnerships and private and public funds (LPs/LLCs), 1031 exchange programs (DSTs/TICs), energy and oil and gas interests, equipment leasing programs, or other alternative and direct investment offerings. The association was founded in 2003 and has more than 5,000 members.