ADISA, a leading national trade association that focuses on alternative and direct investment securities, reported that chief executive officer and executive director John Harrison recently visited Capitol Hill to educate members of Congress and to advocate on behalf of Section 1031 exchanges.
ADISA and other members of the Real Estate Roundtable commissioned a newly released study that focuses on the impact of Section 1031 exchanges and the harm limitations may have on the real estate sector. The report, The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate, is authored by David Ling, Ph.D., a professor at the University of Florida, and assistant professor of finance Milena Petrova, Ph.D., of Syracuse University.
On July 10, the coalition and authors of the study held a briefing with congressional staff at the Capitol Visitor Center in Washington, D.C. and presented the results of the report, which examined 1.6 million real estate transactions over an 18-year period.
ADISA released the following overview of the study:
Results of the study demonstrated that real estate like-kind exchanges are widespread. The study shows that approximately 6 percent of all commercial real estate sales, based on dollar volume and number of transactions, are Section 1031 exchanges. The use of exchanges in high-tax states varies between 10 percent and 18 percent of all sales in their respective market. The authors of the study explained that these percentages are likely understated.
The study also suggests that deferred gains from real estate exchanges are associated with a relatively small static loss in Treasury revenues. The authors estimate that in 2011, deferred gains from real estate exchanges were associated with a revenue loss, in present terms, of approximately $200 million to $3 billion. At the same time, the study reports that replacement exchanges in 2011 are associated with an increased investment value ranging from $517 million to $1.85 billion.
The authors report that 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 8 percent to 20 percent in moderately taxed markets, and between 28 percent and 38 percent in highly taxed markets.
According to the study, real estate exchanges were found to be associated with increased investment, reduced leverage and short holding periods.
The presentation noted 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.”