Webinar: Can 1031 Exchanges Escape the Chopping Block?
Webinar Transcript
Damon Elder 00:04
Good afternoon and thank you for joining us today to discuss the future of 1031 exchanges. I’m Damon Elder, publisher of The DI Wire.com the nation’s leading news source for the largely illiquid alternative investment industry. I’m joined today by panel of true experts on this issue, first we’ve got Keith Lampi in the bottom there. He is the president of Inland Private Capital Corporation, which is the single largest syndicator of securitized 1031 exchange programs in the nation. He’s also joined by a fellow sponsor Louis Rogers, who is the founder and CEO of Capital Square another one of the top tier sponsors of 1031 exchanges. And Louis personally is considered one of the godfathers of the industry which we’ll get into in a little bit. Tony Chereso also joins us, he is the president and chief executive officer of the Institute for Portfolio Alternatives also known as the IPA of course. And of course, John Harrison rounds out our panel he is the executive director of ADISA which is the Alternative and Direct Investment Securities Association. Both ADISA and the IPA are trade groups that represent many of the most active participants in the securitized 1031 change community, and they are significant members of the broader coalition that educates and advocates on behalf of section 1031.
Now we’ve had a tremendous turnout for this webinar with more than 700 registrants, so it’s clearly a topic of great interest. I’d like to thank the audience for the questions that have been submitted during the registration process, and I trust most of them will be addressed during our discussion today. If you’d like you can still submit a specific question, directly to me Damon, d a m o n at The DI Wire.com and we’ll try to work any pertinent questions into the discussion as we go. So, with that why don’t we get started. I assume most of our audience are very familiar with 1031 exchanges, but I think we’d be remiss if we didn’t start our discussion with the background on Internal Revenue Code section 1031. Lewis, again in addition to being a very successful sponsor of 1031 exchanges, you’ve been credited with being one of the founders of the industry as you were one of the original syndicators of securitized 1031 exchanges back in the 90s when you were a partner at the law firm of Herschler and Fleischer. So, I think this would be a perfect question to begin our discussion with you. So, when and why was 1031 added to the tax code and what do 1031 exchanges allow their user to do?
Louis Rogers 02:22
Thank you, Damon, thank you fellow speakers. I don’t know when I became the old guy, but I don’t like it. I’m I’m going to be the young guy today, young guy who’s talking about section 1031 of the Internal Revenue code that was adopted in 1921. It’s been with us largely unchanged for all those years and it’s a golden oldie. It’s real simple as they say down South, you can read it in plain English and it hasn’t changed very much. It basically allows the the the deferral of gain on sale or exchange of business or investment property. Now people get confused, we’re not talking about your principal residence, there’s a provision for that. We’re talking about deferring the gain on investment or business property. Been in the Internal Revenue Code since 1921, was amended in 1923 to eliminate stocks and bonds and things that we don’t know what they mean what’s a show in action I don’t know what a trust certificate is. But those things were eliminated in 1923 and we’ve gone happily ever after since.
The theory behind 1031 is not entirely clear. Back in 21 there wasn’t much of a legislative history, but we think the primary theory is continuity of investment. A taxpayer started with real estate like kind property, and they ended with real estate like kind property and our theory of taxation is based on actually having cash, something that you could quantify not property. And so, the theory was unrealized gains were not taxed they’d have to be some realization event when you swap property for property… farmer A meats farmer B at the Creek, and they swap property tax should not be imposed. That’s the the primary reason continuity of investment. And we’re talking about theoretical gains because they haven’t been realized.
There’s also a second plausible rationale which is just the administrative inconvenience of taxing all these literally horse trades in 1921. What did you trade? Probably traded horses and buggies and how would you tax all those things back in the old days before computers. So that’s the gist of it, the theory has taken hold, it survived all these years and survived the 86 Tax Act. It almost didn’t survive the tax cuts and Jobs Act of 17 and there’s more than a little bit of irony here that it was basically the Republicans who eliminated personal property from section 1031. Now we’re talking about what could happen if there is a change in Congress and in the White House but in 17 personal property was eliminated by the Republicans. And it was Kevin Brady ways and means that wanted to eliminate 1031 entirely. So, there’s a little bit of irony there as we talk about what a new administration could do to us.
Damon Elder 05:46
So, just to clarify real quick and maybe Keith you can jump in here. Originally back when 1031 was added to tax code nearly 100 years ago. Wasn’t it primarily geared towards farmers and people who had large agricultural holdings and perhaps not large holdings of cash?
Keith Lampi 06:04
Yeah, to Lewis’s point, and obviously it was a good historical overview. I think it the genesis, the theory is that it started there, but over the course of time and and as Lewis pointed out this is a provision in the tax code that’s about to celebrate its hopefully 100-year anniversary being on a provision in the tax code. It obviously evolved, and as real estate investment activity became more prolific it became a key component toward you know any and all type of investment property. So, we’ve seen that evolved tremendously over the years, and the provision like kind is somewhat somewhat fluid as long as as as long as it’s investment property for investment property. And it an investor that’s selling raw undeveloped land can reinvest his or her proceeds into a commercial asset a multifamily asset. And oftentimes we we interact with investors that are selling you know a a rental property of three flat in downtown Chicago where where I’m situated currently. And and that investor might roll his or her proceeds into a self storage facility or a you know a medical office building. So like kind has been fairly fluid and and as I said it’s evolved from being the swap of of raw undeveloped farmland to to other types of income producing investment properties.
Damon Elder 07:31
And you’ve all touched on investment properties, does it also apply to single family homes that are not your primary residence?
Louis Rogers 07:39
Yes, rental properties.
Damon Elder 07:41
So, they don’t have to be duplexes or apartments in their family homes qualify?
Louis Rogers 07:45
Basically, any sort of real estate is like kind to any other sort of real estate, and part of what makes 1031 so interesting is the IRS and Treasury have supported us with an enormous body of private letter rulings, revenue rulings, revenue procedures if you remember that one. Without this enormous body of law, we wouldn’t have such a broad frontier on which to exchange. Like kind could have meant exactly light kind, it could have meant a rental house for a rental house. But what it means today is that an investment property for an investment property we’ve had great support from the administration and very broad strict but broad rules.
John Harrison 08:29
I’d like to add one thing Damon.
Damon Elder 08:31
Go ahead John.
John Harrison 08:32
Lewis, I think would probably go back before Kevin Brady maybe Dave Camp actually was the first republican who started eyeing the 1031’s. And the real reason is because they’re looking for people, they have some program or some I guess expenditure they want to pay for, and they think OK maybe let’s look for some loopholes we can close. And that’s why our Dave Camp locked himself in a room for a couple of weeks and started looking at every little thing. I think I think I think Dave back at practice price Waterhouse by now, but he started looking at everything and that’s when the current movement which is really bipartisan in terms of examining everything started. So, I’m no we’ll get that to that later, but I think it even proceeds Brady’s look 17 or you know earlier… so
Louis Rogers 09:23
I’m told that Ronald… Ronald Reagan even took a look in 86 to try to flatten the tax code.
John Harrison 09:31
Right.
Damon Elder 09:32
John, you touched on a landmine there the word loophole. So, I want to kind of discuss a little bit 1031’s as loophole. Chuck Maher who is the senior director of federal tax policy at Washington think tank, the Center for Budget and Policy Priorities, has said that quote unquote or quote 1031 exchanges are a major loophole that just make no sense and that the Biden proposal is way past its due date. How appropriate is this term loophole in regards to 1031 exchanges? I’ll open that up to… you Keith. You looked like you were ready to say something.
Keith Lampi 10:04
Yeah, I well I think that’s an important part of our our collective messaging, and I think a big undertaking that the coalition has has leaned into. You know from a from an industry percent participant standpoint, and we take issue with the characteristic activation that you know this fall into other types of tax loopholes. The key distinguishing feature here that everybody has… we need to convey Is that this isn’t tax forgiveness this is tax deferral. In fact, there was there were several academic impact studies the Ling and Petrova studies is probably going to be cited several times throughout this dialogue. And the key statement in the key outcome in that particular study was that, in effect eventually 88% of tax deferred exchanges eventually end in the payment of taxes. So again, when an investor completes a 1031 exchange, they sell a rental property they reinvest into another investment property that that that tax is deferred not forgiven. And then oftentimes eventually there is a settling up of sorts in the way of of taxation. And I and I think that’s that’s oftentimes overlooked and sometimes mischaracterized with with regard to some of the political rhetoric, when we’re looking at section 1031 is a potential pay for.
Damon Elder 11:29
Keith, we got a question here. I don’t know that our viewers can see it. But we got a question from our viewers. Could you cite that statistic from the Ling & Petrova study yet again? And we’ll talk more about that study as we go
Keith Lampi 11:40
Yeah, it was 88% of tax deferred exchanges eventually end in a taxable event. so, we know often times…
John Harrison 11:49
Only can go back one generation, yeah so 88% it only goes one cycle theoretically you could defer and defer and defer pass but that’s not what happens in the…
Keith Lampi 12:00
Right so it…
John Harrison 12:01
It points out 88% of the time it’s a final tax maneuver.
Keith Lampi 12:05
So, there’s off, so Lewis and I’ve been on panels and when we’re kind of marketing the power of section 1031 exchanges to to investors. We’ll use the term swap till you drop. And there’s a there’s a theory that you know over a series of transactions a buyer and a seller come together and deferral is achieved if you continue that path, and you take effectively take your real estate to the grave there’s a step up in cost basis. The theory behind swap to you drop is again a very powerful tax planning tool but in reality, in effect it’s it’s not necessarily been the case in terms of how transactions have actually settled up. And I think that’s what the Ling and Petrova study did a great job of of actually applying some data and numbers to to kind of making that point.
Damon Elder 12:50
So, let’s talk just briefly about that I want to bring Lewis back in because again I think it’s a highly technical legal aspect. The deferral the swap you drop the step up in basis, so when an investor who has exchanged one or multiple times passes away their property then passes to their heirs and there is a step-up quote unquote passes away their property then passes to their heirs
Louis Rogers 13:11
Yes.
Damon Elder 13:12
And there is a step-up quote UN quote in the tax basis to…
Louis Rogers 13:14
Fair market.
Damon Elder 13:15
Exactly to the fair market which means they have essentially in fact in fact have avoided the payment of the capital gains tax
Louis Rogers 13:23
Yes.
Damon Elder 13:24
Of all those cumulative tax or exchanges. So, I mean isn’t that essentially maybe it accounts for the 12% isn’t that tax avoidance isn’t that a loophole to allow you to avoid capital gains tax Louis?
Louis Rogers 13:36
Avoidance and loopholes are pejorative, those are negative words. The step up in basis is intended, that’s how the tax code was written that’s how it works. 1031 is an exception to the general rule of taxation, but it’s very much a rule. And exceptions are strictly interpreted, that’s why 1031 rules are so strict the days are strict like kind of strict the rules are strict. But we’re talking about congressional intent congressional policy. I would say a loophole is getting a result that was not intended, something not within the spirit and the intent of a section of the Internal Revenue Code. Deferral is exactly what’s intended under 1031 the step up is what is intended in the estate tax. Those are things within the spirit and intent of Congress, not a loophole not something bad not tax avoidance. A good tax planning.
John Harrison 14:33
Yeah, go ahead.
Damon Elder 14:36
Go ahead John I’m turning to you.
John Harrison 14:37
Uh if a farmer had investment property in 20, 50 years ago there was $10,000 when he bought it and now it’s worth you know $5 million. That’s really not what the tax intended as well. They that he would not have a a an an asset on his hands that could never be used or sold, and it would they would just continue to run down and be held. I mean that’s the holding period that happens that that’s one of the reasons the economic velocity of of keeping the real estate moving of improving the real estate of growing the the wealth it’s not an idea that you just sit on it and try to avoid taxes by not by not ever selling it.
Louis Rogers 15:24
(Cross talk)
Damon Elder 15:26
Sorry Louis, go ahead.
Louis Rogers 15:28
Go ahead.
Damon Elder 15:29
I was gonna add, you know how does depreciation, which is you know another tax advantage of real estate ownership. How does that tie in if at all to 1031 and the value of this process?
Louis Rogers 15:39
It cuts both ways, there’s a price to be paid for 1031. You have much reduced depreciation deductions, greater capital gain taxes, and greater recapture. It’s not a free lunch getting this deferral. Depreciation is simply the the allowance for wear and tear because real estate wears out overtime, and in the code since I can’t remember when forever.
Damon Elder 16:03
So, I want to I want to bring Tony into this discussion here a little bit. I think clearly you all seem to agree that loophole avoidance those are not an accurate description for 1031 are not fair.
Louis Rogers 16:13
Exceptions.
Damon Elder 16:14
Exactly exceptions. But Tony we we’ve already brought up and I know we’ll talk more about it the Ling and Petrova study, could you kind of give us a little background on that because I know the IPA as well as ADISA have been participants in in the promulgation and the development of this academic study which again we’ll talk to a bit more who are Ling and Petrova what is the study that folks are starting to refer to?
Tony Chereso 16:36
Ling and Petrova are two leading professors who focus on on real estate. They had been involved in the original study that was commissioned by the 1031 coalition led by the real estate roundtable. There’s grade John you may know the exact number but there’s greater than it does in real estate associations that were involved with commissioning that initial report. We recently had an updated this year on this just finalized mid year and and that report is sort of built off of the original study. But all also took it a little bit further by actually diving deeper into specific exchange data that wasn’t once available to us. And so, they were able to get into some some additional information additional data sources either through IPA… IPX 1031 exchange through Marcus Millichap and other sources to really be able to to sort of breakdown the information in more meaningful layers for that to represent the sort of the true essence of what what the impact of 1031 is and how It’s being used.
Damon Elder 17:53
And real quick, we did have a follow up question which I think is cogent to the discussion…
John Harrison 17:56
There’s a…
Damon Elder 17:57
Go ahead john.
John Harrison 17:58
… plug for Tony, they Tony I believe the you have a webinar from Ling and Petrova on your website right? That people could view if they wanted to see the presentation, and we have a copy of their original paper on our website. So, we either IPA.com or ADISA.org. I hate to be you know but if in order to cite it if you want to actually read the the studies or see the presentation on it you could go either one of those two.
Tony Chereso 18:24
You can get all the details.
Damon Elder 18:26
Well real quick before we move on this 88% regarding the payment of taxes during an exchange. One of our our viewers asked for clarifying question. They’d like to know so when you’re referring to that 88% of 1031 exchangers it’s the heirs that are selling the properties when they I don’t think that’s what that statistic refers to. Lewis you’re shaking your head.
Louis Rogers 18:50
88% of exchanges result in a taxable transaction. And it’s been one exchange or
Damon Elder 18:54
Is that mean one exchange or is that along the way? Cause again you can do multiple exchanges over the lifetime.
Louis Rogers 18:59
I think it’s along the way 88% of the of the gain ultimately gets recognized and taxable.
Damon Elder 19:05
OK.
Louis Rogers 19:06
It’s a fairly short time. Does anyone remember is it 3-5 years 10 years?
Tony Chereso 19:11
I I don’t remember.
Louis Rogers 19:13
Pretty short.
Damon Elder 19:13
John, do you have something?
John Harrison 19:14
Yeah, the average length of time is a little over three years I believe something like.
Louis Rogers 19:19
It’s pretty short, surprisingly.
Damon Elder 19:21
All right don’t make me mute any microphones, this is turning into a presidential debate. Keith, I know you had something you wanted to add, why don’t you go ahead.
Keith Lampi 19:27
Just to just to put a kind of a period at the end of that 88% stat. So, the 12% that that do ultimately achieve tax forgiveness, those are those are situations where an investor continued along their exchange path and then the liquidation was was completed by the heirs and then they received or achieved that step up in cost basis. But You know I think it’s you know that that data point there’s another one that’s in the Ling and Petrova study which suggests that out of every 1/3 of transactions a portion of the exchange is is paid paid in taxes. So, there’s a portion of boot that is ultimately achieved which which results in the payment of taxes. And I think what a lot of this was meant to characterize is that you know when we think about you know using terms like loophole when when we think about the the the scoring that lawmakers apply to section 1031 and they look at all the the transaction volume and they say well if we taxed all of that here’s the here’s the dollar amount that we would have for other other purposes.
It’s Important to kind of take a step back and and appreciate and and analyze the actual interaction and human behavior behind how investors how taxpayers are ultimately interacting with with this section of the tax code. So those are those were real life data points as as Tony mentioned earlier. We didn’t have access to a lot of these these data points before the Ling and Petrova study that engagement that the the coalition can undertook provided a much better kind of numeric thought pattern behind what was otherwise somewhat anecdotal.
Tony Chereso 21:03
We’ll come we’ll come back to this conversation a little bit later Damon when when we do start to talk about some of the advocacy initiatives and and I’ll bring it back up. But but I think the point I want to make right now, and we’ve had this conversation up to this point in point of time. This is not a democratic republican you know this this is an Issue that whether Democrats are are in in control of the White House or Republicans are in control of the White House. It’s an issue that keeps on coming up, and so we need to continue to arm ourselves with the research Ling and Petrova. We’re up in the process updating data our research report by EY we need to have all this information available to us so that we can educate the legislators on the on the true benefits of of how their constituents use the 1031 exchange.
Damon Elder 22:01
And like you said Tony, I mean I think historically when people have looked at it from a legislative perspective, 1031 has garnered widespread bipartisan support. But it’s a aspect of the tax code that I think is largely misunderstood or not people just aren’t aware of even in the halls of Congress I mean is that a fair statement?
Tony Chereso 22:19
It it’s yes, and you listen we can point to just the last election when we had what roughly 9 new senators and 89 House members. And and frankly when we were out visiting with many of those new congressional members, they didn’t know what 1031 was. And so, we’re starting from ground zero and you got to imagine that happens every two years basically. So, you know we we got some fresh blood coming into Congress on a regular basis and it really is important for us to have real supported research and data to be able to help inform them as they’re looking at their various options and going back to what John was saying in regards to pay forwards this continues to come up as a pay for. And you know we can argue whether the actual number that they’re applying to it as it relates to what tax benefits, they’re going to achieve by eliminating the tax code. But the reality is is that we have to we have to forget about whether it’s a Democrat or Republican issue. We’ve got to we got to continue to stay vigilant working with our coalition partners making sure that congressional members old and new are fully fully aware of how this tax code is is used. And it’s interesting also because and I’m jumping around and don’t mean to jump ahead of you here Damon because you said not to do this, but I think…
Damon Elder 23:42
You’re not the first person to ignore me. My wife does it every day.
Louis Rogers 23:46
Go for it, Tony.
Tony Chereso 23:47
Yeah so, I think you know one of one of the interesting things that if you if you sort of peel back some of the data in it and there’s a lot of great information in the link that we can’t get into here. But between 10 and 20% of the commercial real estate transactions are result are result are or result of a 1031 exchange. So, let’s just use you know that that range for example, if we just look at real capital analytics in 2019. What they reported as commercial real estate transactions $560 billion so we’re talking roughly 56 to $112 billion in exchanges, you know again rough numbers. But what if you look at according to the IPX 1031 exchange data and and they’re leading 1031 or comment they’re in their space and they played an important role in providing some real live data for Ling and Petrova on this latest study. The average exchange is fairly low, and what what that suggests is is that it’s small you know individual investors not large institutional investors that are utilizing this…
Damon Elder 24:55
Tony, you’re jumping way ahead. Let me put a pin on this point then we’ll move on, and we’ll get right back to this topic, I think. But just personally I can tell you that you know in another lifetime I was a congressional aide, and I certainly knew nothing about 1031 never heard of it until I came into the securities world. And I know an awful lot of folks who work in the halls of Congress and again it’s the legislative staff that really pulls the levers and and they’re they’re largely don’t know all these rather arcane aspects of the tax code and lots of the other millions of pages of laws we have on the books. So, we’ll get back to that point a bit later.
But I do want to move on a little bit, we’ve talked about the background and what 1031’s do what they are. But give us a little aspect a little insight into what is the impact? I mean how large what kind of numbers are we talking here what kind of volume of exchanges? How much money are we talking about types of of assets that are being moved which I think we’ve covered I mean obviously like kind real estate. but who are the people doing this are these super wealthy folks who are you know utilizing this takeover tell us everybody all kinds of regular folks…
Louis Rogers 25:56
All kinds of people. Everybody.
Damon Elder 25:57
Louis, Take over. Tell us.
Louis Rogers 25:59
Everybody, all kinds of regular folks. but mostly the mostly your neighbor next door. Not so many billionaires not many corporations only 5% of real estate owned by corporations. Most people are regular folks who are using 1031 to improve their lot in life to buy a property that is more profitable for them somebody’s buying a property from them that’s more profitable to the other person it creates value each property can reach its highest and best use but mostly we’re talking about regular folks we’re not talking about billionaires.
John Harrison 26:36
Half half million dollars is the average like kind exchange.
Damon Elder 26:41
That’s the value of the property being exchanged.
Louis Rogers 26:43
Half a million.
John Harrison 26:43
And that’s usually a 30% or so upgrade people often buy up. And so that’s where the the boot comes in that you know Keith was talking about. But that’s where the advantage happens it’s this is not a as you said this is not some big corporate management thing, this is something that can be done by the average real estate investor who’s who’s moving really a half million dollar our property.
Louis Rogers 27:14
And again, thanks to the IRS and treasury for giving us safe harbors, and qualified intermediaries for safe exchanges at modest cost. Everybody anybody with an investment or business property can structure an exchange without much aggravation or cost.
Damon Elder 27:30
Keith, what’s the typical what is your typical client investor in the 1031 exchange programs that Inland sponsors you know? What do those investors look like you know on average?
Keith Lampi 27:41
It it’s pretty consistent with the the data that Lewis and John threw out there, you know the the middle ground is usually around half a million dollars. I mean there’s a broad there’s a broad kind of bookend you know on on the lower side of that and on the considerably higher side of that as well. But but oftentimes it it tends to be individual investors; you know either through their trust or their their LLC. Again, I think the takeaway is you know there’s a perhaps a misperception that this is large you know multi million you know type dollar transactions, and that’s that’s oftentimes more the exception than the rule. So, but I wanted to get back to one of you’re your preliminary question Damon the the size and and scale kind of the magnitude of you know what section 1031 brings to the table.
So in in our securitized world you know we’ve been running over the past couple of years on average raising roughly three billion, three and a half billion in equity as an industry. So, if you apply you know 50% leverage to that you know what’s called that 6 to $7 billion in transaction volume. There’s not there’s not a pure data source for this but by most accounts and we’ve had a lot of dialogue with the qualified intermediary industry attempting to capture how big of the 1031 universe is the securitized market. And and by and large the common response is that give or take it’s around 10% of the overall universe. So, you know if you if you kind of do the math and you you kind of spread that across the the billions of dollars in in transaction volume that occur as a result of section 1031 exchanges. That that’s that in a in effect is is largely the the concern for the real estate market as a whole, and a lot of what we’re talking about it.
You know the common concern is that if section 1031 were repealed or in some instance minimized the the capabilities of it it could create a a lock in effect. You know property owners that would have otherwise been sellers may sit on their assets longer, may not sell, may not transact. And if that were to occur the the spillover effect which which has broad implications across the rest of the economy could could actually have a detrimental impact on on GDP. And I I hate to keep going there but that was a big part of also what what that Ling and Petrova study illustrated. You think about the the taxable revenue that occurs when a real estate transaction takes place, when a buyer and a seller come together. What a data point that was thrown out there in the study was that 30… 30 jobs are created as a result of a real estate transaction and that’s anywhere from you know the attorneys that are facilitating that transaction title companies surveyors the the laborers that that oftentimes are are hired to improve a property after it’s purchased there’s there’s local transfer taxes that are paid. So, if you if you if you take 1031 out of the equation and if you carry my initial thought to its logical conclusion. If that has this lock in effect and it dramatically reduces transaction volume, there’s a lot of taxable revenue that now is no longer on the table. And again, I think that the importance of some of these these studies that were created particularly Ling and Petrova was to kind of capture that in a in a numeric based fashion.
Damon Elder 31:04
I definitely want let’s broaden the discussion to the grander economy and the impact that 1030’s provide. Because as you mentioned Keith, the securitized industry which again we’re most focused on but again it’s a tiny segment really of the 1031 exchange aspect of our of our economy isn’t that right? I mean Louis, I think you have some insight on that I mean non securitized 1030 ones that you know CPA’s may utilize real estate agents etc. Far larger amount than three to six billion.
Louis Rogers 31:31
Most exchange most exchanges are regular folks they sold a duplex and exchanged into another rental property. The securitized his small part of the of the number of exchanges.
Damon Elder 31:44
Go ahead John or I’m sorry Tony.
Tony Chereso 31:47
Yeah so, it may be a small in in in some people may say an insignificant portion of the total exchange. But we we’ve been working on a our data and research committee been working on gathering some data specifically related to our industry. And just throw out a couple numbers, from 2011 to 2020 total purchase price of syndicated transactions is $27 billion. That’s not an insignificant number that’s that’s you know roughly 1900 or or almost 2000 commercial real estate investments. And that that equated about 643 different syndicated offerings. So, you know although we are we we talk about it as a small percentage of the total exchange marketplace, it’s not an insignificant portion of it. So, our industry plays an important role, and it also serves a very important constituent investor, so I don’t want to lose sight of it.
Damon Elder 32:49
Well, I think that’s a great point Tony. But I think what I’m trying to suggest is that really any change to 1031 would have not only a significant impact on the securitized world, but the March much larger world of real estate exchanges in general. I mean doesn’t the Ling Petrova study I think quantify what the total volume is?
John Harrison 33:08
So, there’s a second study we use for that data. Ling of Petrova really does the effect of real estate the 1031’s as applied to real estate. To apply 1031’s to the overall economy there’s a second study Ernst & Young and he and wife study and it’s being updated both Tony and I are involved on that study as well. The earlier one which was done in 20 15 showed that net of tax revenue, if you cancelled if you got rid of 1031 you would cost the US economy $12 billion per year on average straight hit to the GDP net of the tax income. So, it is a lose lose lose if you get rid of it, and it also depends on where you live. Because California and Damon you’re out there with with those folks and California is about 40% of the operation, with with 1030’s. And then so it’s a deep blue state, and you’ve got New York on the other and the state of Washington the Oregon also Colorado. Those blue states really form I guess the almost a majority of the of of the transactions or the volume in.
Louis Rogers 34:29
With the money escaping…
John Harrison 34:31
Yup.
Louis Rogers 34:32
To the Southeast Texas and Florida.
John Harrison 34:35
Yeah, wasn’t it California that tried to rein that in at some point though
Louis Rogers 34:39
They have to claw back, they have they have rained it into an extent. And it and it’s worse than that because we have an enormous budget deficit that’s growing. We have politicians that want programs good some very good programs, and they see this big shiny thing 1031. But it’s based on a phenomenal flaw, because the joint committee on taxation when they run the numbers, they’re static and so they say OK no more exchanges every sale is taxable. And what’s the tax and that’s the number they’re using but if there were no 1031 how many how many people would hold their property forever for the lock in effect or at least refinance it a few times or hold it for decades. And so that revenue is not there it’s a tiny fraction of that revenue and then as John says we lose what 20 billion a year in our economy.
Damon Elder 35:36
So, I think what I’m hearing then is that I think you all agree that 1031 impacts the economy in a positive fashion. It wouldn’t simply be capturing taxes that are deferred under 1031, you would be hurting the general economy that benefits from all this transaction activity all the real estate activity the sales and the purchases and John, you said it was a 12 billion net loss to the GDP is that correct.
Tony Chereso 36:00
17 billion.
Damon Elder 36:01
17 billion.
John Harrison 36:02
Yeah. I made the depends on what what period you look at yeah.
Damon Elder 36:04
Right.
John Harrison 36:05
It’s it’s a big number.
Damon Elder 36:06
Ok.
Louis Rogers 36:07
You could create a real estate recession like we haven’t seen since the 86 Tax Act and the passive loss rule…
Damon Elder 36:14
Ok.
Louis Rogers 36:15
That’s what we’re talking about.
Damon Elder 36:15
Why don’t we move into really the point of the webinar then is, so we’ve got Vice President Biden who if you believe the polls is almost certainly going to become the 46th president of the United States. I think most pundits are expecting the Senate to be taken over by the Democrats to receive at least a achieve at least a slim majority there, and the House of course I don’t think anyone expects is going to do anything but become perhaps more blue. So, assuming complete control of the levers of federal power under the Democrats, Vice President Biden has proposed what exactly, Tony can you one take that one?
Tony Chereso 36:53
So, he he’s his proposal Is eliminating certain real estate industry tax provisions. So that that’s that’s but he is on on record for stating stating publicly that he would eliminate the ability to defer capital gains. So, although if you go to his website and and you you look at his text tech policy it doesn’t specifically state that state that, but he has been on record on several occasions statements stating that he would eliminate the ability to defer capital gains.
Damon Elder 37:27
And I believe members of his campaign have specifically cited 1031’s as a loophole that they would seek to close. So, I mean it’s quite clear that his proposal would impact directly 1031 but what are some of the finer details I mean they’re not calling for an outright elimination of 1031 what exactly are they asking for?
Louis Rogers 37:49
They’re eliminating 1031 for income over 400,000 nobody knows what that means.
Damon Elder 37:55
Right.
Louis Rogers 37:56
The whole the whole plan is about 18 words, to be paid for by rolling back unproductive and unequal tax breaks for real estate investors with incomes over 400,000 and taking steps to increase compliance for high income earners. Does the 400,000 include the game being deferred or is that taxable income don’t know this is not legislation this is a plan.
Damon Elder 38:20
So, let’s assume and that 400,000-income annual income 400,000 per person, is utilized a lot as a baseline for Vice President Biden and a lot of his economic proposals and and he’s sworn up and down that any tax changes rather that’s 1031 or any other tax provision…
Louis Rogers 38:37
400,000
Damon Elder 38:38
… would not impact anyone who makes less than $400,000 per year. So, let’s assume for purposes of our discussion that we’re talking about an individual investor in one of your programs or or any other program or just a straight 1031 exchange, their income falls beneath 400,000. How would this alteration this cap on section 1031 how would that impact the 1031 exchange industry and particularly to Keith and to Lewis to your companies?
Louis Rogers 39:08
If it includes… go ahead.
Damon Elder 39:11
Tony, you go first.
Tony Chereso 39:12
I’m gonna say I don’t I don’t think anybody really knows.
Louis Rogers 39:15
It’s unknowable.
Tony Chereso 39:16
I don’t know I don’t think we have an answer it’s it’s too vague as Lewis indicated so we don’t have enough information in substance to be able to really answer that question clearly.
Damon Elder 39:27
Keith, go ahead.
Keith Lampi 39:28
Yeah, I would add you know it’s interesting we we were forced to kind of think about this years back. I think the Obama administration suggested $1,000,000 cap per year per taxpayer on the deferral You know gains under section 1031. And we kind of took some time to analyze what impact that would have on the on the business. I depending on how you interpret the the $400,000 threshold, there there are probably some similarities in that analysis, but it’s very difficult not a lot of great data to anchor on. I guess from a high-level perspective I would I would say it will have a fairly devastating impact on our industry. If if you were still able to interact with, you’re your smaller smaller transaction more mom and pop related investors the industry may still be in a position to to go on. But you know I project industry sales dropping you know by 50% or greater simply by virtue of that effect.
So, there’s a lot of there’s a lot of dialogue obviously a lot of a lot of rhetoric a lot of speculation surrounding this, and you know we’ve we’ve sort of been trained over the years to to think about the world through a multitude of lenses. But the way I’m kind of evaluating this from a sponsor perspective is you know assume that everything’s on the table assume that it’s an outright repeal, and that’s why it’s so it’s so critical for us to to to kind of update these the the data update our studies update our messaging and and and band together to to kind of highlight what I believe to be the right facts the facts the data the numbers are on our side if you if you take John’s GDP loss and taxation to the to its logical conclusion. There’s a lot of lack of awareness there so it’s incumbent on all of us as industry professionals to continue to get our messaging out there to educate on that.
Damon Elder 41:24
Real quick John, that that the GDP number you cited what study did that come from again?
John Harrison 41:29
From Ernst & Young, they’re earlier study it was from 12 to 20 I think 20 was the top end as as Tony said. I’m I’m you know and natural conservative so I’m going to give you the bottom end because the 12 billion was the net loss. Now that was number of years ago, we should have the new one out I think I think it’s due out by the end of this month from Ernst and young they’re updating it. And and they’re looking at just 1030’s effect on the US economy and the GDP. But I I got to say one thing and I I think this is to build on what Keith, said I’ve never been I’ve been in a room with folks that to the left of Abby Hoffman and still when they see the numbers, when they see the numbers and they see what good this does all of these other threshold amounts are sort of go out the door. $400,000 is really just a is it is not an effective measurement to to do any of this stuff it just…
Damon Elder 42:30
I think your dogs are in agreement with you as well.
John Harrison 42:33
The FedEx guys are staying maybe he’s delivering something good on that.
Damon Elder 42:37
Well, so let’s keep keep moving on, this I think we have the natural flow going on here. Let’s get to what I’ll call a threat assessment to 1031’s. You know as as you’ve all or several of you at least have mentioned during the dialogue, calls to eliminate or adjust section 1031 or nothing new. Like you said earlier you know under the Trump administration there was a significant adjustment to 1031’s. How real is the quote unquote threat from the Biden proposal as vague as it may be what are your personal takes on this? I mean is there a significant threat to 1031’s that we should take very seriously? Is it just another political talking point during a highly charged and emotional campaign? What are your thoughts on this Tony why don’t we start with you?
Tony Chereso 43:22
I think I think we need to really take it as a serious threat. You you just can’t you can’t assume that it’s a political talking point. We’ve seen an erosion of it in the last half act as as Lewis mentioned earlier it is something that continues to come up administration after administration. And you know although we continue as a coalition because we put forth a good argument around the benefits of it we can’t lose sight of the fact that and is John had mentioned earlier and especially considering where we are and that are in economy and and and sort of what the next administration whether it’s Trump or Biden face there’s going to be some significant hurdles that they’re going to need to look deep and figure out ways to be able to pay for some of the some of these programs. And so, you know we we we shouldn’t take it lightly, and that’s one of the reasons why we can’t afford, and we’ll talk about this a little bit later, but we can’t afford just focus on this as an issue at the at the time of every election. This has to be you know consistent advocacy initiative working hand in hand with our coalition to make sure that we are educating the the the congressional members on the on the underlying benefits of this important tax.
Damon Elder 44:45
And again, just to frame the debate or the discussion. I’m assuming and that again the White House the Senate and the House will all be controlled by the Democratic Party. So I I think would you agree that if the Senate were to remain under republican control this is probably a moot discussion Lewis giving to add?
Louis Rogers 45:02
Moot discussion, but this time feels so different I’ve never felt so divided. We can’t even we can’t have Thanksgiving because of COVID but if we did, I couldn’t talk to my brother and sister because of the politics. That this feels like an element of class warfare and hate for a real estate owning president. And then there’s something that is very very tricky little point money is escaping the northeast the West they’re very expensive parts of our country escaping to the southeast where we live Texas and Florida. There’s an enormous flow of money out of those places, and if I were in one of those places, I might want to stop it at 1031 is a is allowing the money to flow another reason to stop it is to just to lock the money in.
Tony Chereso 45:57
And Lewis II would I I would respectfully disagree but if with you if the Senate remains republican…
Louis Rogers 46:06
We’re ok.
Tony Chereso 46:07
… the house I I think it’s still a threat.
Louis Rogers 46:11
Do you really?
Tony Chereso 46:12
Yeah, I do. And I’m not one the yell fire in a crowded movie theater. I just think that there’s there’s a lot of challenges ahead of the next administration and next Congress, that everything is going to be looked at real closely. And the fact the matter is that this has been a point of of topic for let’s let’s call it the potentially the Biden administration administration and it’s not going to go away.
Louis Rogers 46:44
That’s your advocacy and education right. That’s why we need to always lobby and hill days and education and so on.
Keith Lampi 46:52
Yeah Tony I’m with you there. I I mean I I think you know we we’re obviously we’re forced to think about the outcome of the election through a multitude of scenarios and having balance in Congress would would certainly help help the dialogue that we’re having and perhaps help our our ultimate conclusion that maybe it’s it’s a little less tenuous in a situation where where the Senate remained red. But I mean we’ve been I’ve been in this industry almost 20 years we’ve been looking over our shoulder you know around this dialogue in this debate and it’s growing in vigor. I think that you know when we undertook comprehensive tax reform and and John, Tony, Lewis we all we all kind of came together on that front. I think we viewed that as the you know kind of being in for the fight of our lives. And things kind of settled in in into a fashion that I think many of us concluded, OK it’s gonna be a while before we have to, we have to really sharpen our pencil and and and re undertake this this this narrative. But what’s become abundantly clear is it’s an ongoing education it’s an ongoing advocacy process which you know obviously ADISA and IPA of have been leaders in and I think I I don’t let my guard down if the chips fell in in the scenario that that you framed Damon.
Damon Elder 48:12
John, I think you had something you wanted to add.
John Harrison 48:13
I will agree that if it’s a split, the White House is blue the house is blue and the Senate is red, I think it becomes more of a timing issue. Because obviously the Republicans are going to have to sign off on anything that you’re going to have you’re gonna have hearings in in which 1031’s are vetted. So, we need to be out front of the narrative on that. And I don’t know that the man in the street this is not a big message for him this is a this is really a step removed but so in that regard cooler minds can prevail. And this is actually what has been happening these times we have one we go in we have the academic studies and these, academic studies are are are pure we pay for the study no matter what their results.
This isn’t a this isn’t your year-old industry study where if it if it doesn’t turn out right, they throw it in the trash you know this is going to be published whether it comes out in in our favor or not. These studies are coming out and showing the advantage to the economy no matter what of 1031. So, I I think it would take somebody who’s almost foolish to look at it. And and I don’t know that the ambient emotion and that’s what you’re talking about Louis the ambient emotion of the of the room which is charged by politics tends to get diminished and in some ways neutralized when you get in the backroom and you’re dealing with a bunch of accounts, and you’re dealing with with legislative staff and you’re just saying you know here are the number here’s what happens if you cut this this is the cost it’s going to have and it’s going to have a big cost in California it’s going to have a big cost in New York and these other places. And and it’s going to have also have a cost in Texas the places where it’s not going to be as big a cost aren’t really political powerhouse places.
Damon Elder 50:09
Well, I think that’s a good segue then. Why don’t we talk a bit about again sticking with our hypothesis that the White House will, and the Senate will come under democratic control. What would the process be if they were to pursue changes to 1031? What what has to happen what kind of timelines are we talking about what is the process? What is the legislative process that that would begin? And and again what would that time frame look like?
Louis Rogers 50:34
The goal is to undo the tax cuts and Jobs Act, but there’s always nibbling around the edges. And the tax codes are intertwined the sections are intertwined. The regulations… the it’s frightfully complicated and it doesn’t happen overnight. Even if you want it to tax cuts and Jobs Act took what a year, the 86 act took fairly you know passive loss rule was fast, but it took a while. This is not something that’s going to happen in January, maybe it’s something January 2022 not 2021. It’s a very big task to redo the tax code. It has a lot of ramifications; you have to run numbers and rerun numbers and whose ox is gored. And one of our challenges is we’re very small as an industry, if our if our ox is gored not too many people scream compared to the the income tax rates or the capital gain rates or the step up in basis that affect all people.
Damon Elder 51:38
Well, I think Tony and John this is probably a good point for you guys are talking, because again you’re the leaders of large agrapha advocacy groups that are part of an even larger coalition that looks to protect and educate in regards to 1031. So, let’s say it’s November 4th Joe Biden has won election the Senate has turned blue. What do you guys and your allies on the coalition and the advocacy front start to do and and what does this process look like in your eyes John want to start with you?
John Harrison 52:09
Well, it looks like a prolonged and severe attack that we mount to really educate. Because education has been the key motive here. It would first be on full briefings before different congressional committees. And you used to be on the hill, you know how these how these work. It starts with Ways and Means. Um because that’s going to be the most important thing. And if you can imagine if the if the Senate turns blue who’s going to be the chair of the Senate budget committee it’s going to be our friend Bernie Sanders. So, you’re looking at a situation because right now he’s ranking. So, if you’re looking at a situation where it’s all hands-on deck to really explain the situation, to get us out of this ethos of class warfare because this is one of the few issues that cuts across class warfare as Lewis pointed out the beginning. This is a little guy thing as well as a big this is everybody thing. And so, I I don’t know that our we don’t have a problem with our product, we would have a problem with our marketing and teaching people about our product. We start full briefings on the hill the usual then you wait then we go to target MOC’s. So then when we start targeting who is particularly important and then after that it becomes grassroots, and you know Tony and IPA and ADISA coordinate as well as with…
Louis Rogers 53:40
NEA
John Harrison 53:42
Yeah you could do that and even though we’re small in terms of our segment, you’re talking about us as Tony said before 10% of commercial real estate that’s a big damn number. We’re not talking about small taters here so it’s somebody’s going to pay attention. But there’s going to be a lot there’s packs out there involved I know IPA has a pack we’re part of a 1031pack.org. So, there’s different packs out there that will help get us in front of the right people. And then we trot people in not you Damon, but we will trot in you know Keith and Lewis and folks like that and work together. And I’m hopeful because I’ve seen it happen before we’ve all seen it happen before. But I I will I I beg you to believe that the mania it’s on the street about class warfare and all doesn’t travel well into the corridors of real money and how this works for the budget of the United States. And people say yeah this looks like a cheap sugar high we can grab, but it’s going to ruin our health um you know it starts to fade it’s not as bright and shiny as it was.
Damon Elder 55:00
Tony the IP is very active in the legislative advocacy arena, both independently and as part of larger coalitions. What does the coalition, I think John hinted at it but what does the coalition for 1031’s look like? Who are your allies from an organizational perspective? And what can individual people do to one stay on top of this issue and become participants I mean as a part of the democratic process?
Tony Chereso 55:25
Yeah so, I would remiss if I started going down a list of who’s part of the real estate coalition. But it’s led by the real estate roundtable, we have large firms like in NAR, National Association of Realtors you have Nareit in a in a variety of other industry trade groups that have direct and indirect impacts as a result of commercial real estate. That this particular coalition is clearly led by a real estate roundtable the initial EY study, although on the… no I’m sorry the Ling and Petrova study was led by the real estate roundtable. The FEA is is taking the lead on the updated EY study. And I think going back to what you’re saying this is really a coalition. We are an important IPA and in in ADISA are important element of that coalition, and we represent a very impactful constituent. And all the all the syndicators all the financial professionals that represent the investors that go into these particular transactions play key role in our impacted greatly ultimately and investor gets impact.
But the coalition efforts that have started already in regards to updating the both of the research reports is absolutely critical. And we’ll be used as in a very impactful way of going move forward. But this is really a broader coalition initiative, and one of the things that we’ll be working closely with John and I within the product coalition is how to message that out. The timing that messaging who we’re going to be reaching out to identifying the right congressional leaders that we need to meet with. To get behind this particular issue to make sure that as they start moving through the process of legislating and determining how they’re going to apply certain proposed tax cuts that the individuals that are in the room making those decisions clearly have the right information are well informed and educated so that our voice and our industry in this in this code section is properly represented. So, it’s expanding our congressional contracts and contacts and in relationship is critical, and we can do that ourselves and we do that often on a regular basis. But we do work with a broader coalition to make that happen as well.
Damon Elder 57:50
We have had a few questions come in on similar topics that I wanted to address before we wrapped up. Largely has to do and it’s a very theoretical question there may not be a good answer. But I’m going to have Lewis start because it is a legislative slash legal question. Assuming some legislation comes along, and it’s passed into law that would adjust 1031. How would it impact folks who are already engaged in a 1031?
Louis Rogers 58:15
Sure.
Damon Elder 58:16
Would it be retroactive? What do you see there typically, and what do you expect?
Louis Rogers 58:21
Typically, there’s a transition rule. For real for real estate exchanges entered after January 1, 2022, 1031 is repealed. So, there’d be a typically a period of time for transition. Another version is a binding contract exception, for anyone under binding contract on such and such a day. Typically, there’s enough time to plan your affairs. Sometimes it’s a long period of time. My recollection on the passive loss rule is it came and hit us overnight. Went into committee and it came out essentially retroactive so there’s precedent for it and the passive loss rule essentially killed real estate for what five years or so after 86.
Damon Elder 59:06
But typically, we do see laws put into…
Louis Rogers 59:09
Typically.
Damon Elder 59:10
… place that have such an impact that would give time frames out in advance…
Louis Rogers 59:14
Typically.
Damon Elder 59:15
… finish up here and people who are sitting in a 1031 exchange now I think lead logically we could assume would not necessarily be impacted by a subsequent change to that law is that fair to say?
Louis Rogers 59:24
The odds are you’d have time to plan your affairs for pending transactions, and maybe even speed up a few.
John Harrison 59:30
There would be ex post facto court challenges too that would slow it down I would think, Louis I would usually.
Louis Rogers 59:36
If the legislation’s passed.
Damon Elder 59:39
And I mean the constitution actually has a provision that says, the Congress may not pass a law that impacts people retroactively whether or not that would be something you could litigate as another question of course.
Well, we’re right at an hour guys. I think this has been a very educational and insightful discussion. Real quick, some people have asked for more information regarding the Ling and Petrova study which we’ve cited multiple times as well as the Ernst & Young study. So, I think John you had referenced that the original 2015 Ling and Petrova study is available on the ADISA website is that correct?
John Harrison 1:00:13
Yes, it is…
Damon Elder 1:00:14
And I believe on Tony’s as well.
John Harrison 1:00:16
And I believe on Tony’s IPA website as well, and also the Ernst & Young original study. If we don’t have enough, we’ll get it up but that one also had other than real estate in it at that time so it’s probably not as valid. I know Tony has a webinar that has the data on it of the Ling and Petrova presentation. I think that’s available right Tony on the on the webinar? We have we have a little booklet shameless plug here that’s free for anybody online. I think Keith you helped put this together so appreciations to you. But there’s resources out there and there are we’re going to be going out with grassroots information as we get closer in so uh stay tuned.
Damon Elder 1:00:58
So adisa.org, real quick Louis, adisa.org is a great resource. IPA.com that’s a Tony’s website, the Institute for Portfolio Alternatives has a lot of information as well the dior.com of course is a new site that tracks this closely you should all be subscribed to The DI Wire.com and get your Daily News source. Um Lewis you had something you wanted to add?
Louis Rogers 1:01:19
One last PS I forgot to mention. The proposal the Biden proposal is pre COVID, and the world has really changed in the last nine months seriously changed. And would likely cause rational people to think about economic dislocation at a time when our economy is already super dislocated.
Damon Elder 1:01:40
OK, I think that’s a good point and we could have a whole other discussion surrounding that. And perhaps we will in the near future. But again, thank you so much folks we will have a recorded version of this if you’d like a link to it please email me at damon@thediwire.com and we can provide that we’ll probably put it up on our news website as well.
Again, thank you John thank you Tony, Lewis, and Keith. Again I think this is an exceptional webinar and I think again I certainly learned a lot I hope all of our viewers did as well. So, thank you again.
Tony Chereso 1:02:11
Thanks guys.
John Harrison 1:02:12
Thanks everyone.
Keith Lampi 1:02:14
Take care.
Damon Elder 1:02:14
Bye bye.
Louis Rogers 1:02:15
Keep the faith
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