Title of the Article : “The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate”
Author Information : Milena Petrova (Whitman School of Management, Syracuse University)
David Ling (Warrington College of Business, University of Florida)
Year of Publication : Science Daily (2015)
Summary of Findings : Like-kind exchange rules have led to a more dynamic real estate sector by encouraging increased investment and reinvestment activity, allowing real estate owners to better allocate resources and decreasing levels of debt in commercial and multifamily real estate transactions.
Research Questions : How does the "like-kind exchange" tax provision strengthen the U.S. economy?
What we know : Like-kind exchange or “1031 exchange” rules recognize that exchanging one business or investment property for a similar property does not change a taxpayer’s economic status and therefore should not be taxed immediately. This rule encourages property owners to expand their holdings or reinvest in new businesses, allows capital to flow freely and ultimately supports US job creation and economic growth.
Novel Findings : Removing like-kind exchanges would decrease property values and net investment, increase holding periods, and increase the use of leverage to finance acquisitions. These micro effects are likely to have macro-economic consequences as well by decreasing construction and investment activity in commercial real estate markets, which would depress employment in markets where like-kind exchanges are commonly used. It is critical to fully understand the positive economic effects of the like-kind exchange provision before considering any changes to the policy.
Novel Methodology : This is a first-of-its-kind study that analyzed more than 1.6 million real estate transactions over an 18-year period.
Implications for Practice : On average, a taxpayer using a like-kind exchange acquires a replacement property that is $305,000 to $422,000 more valuable than the original property – additional value that is invested into the community. Likewise, the study shows properties acquired through like-kind exchanges are more likely to undergo building improvements and expansion, ultimately creating more jobs.
Implications for Policy: Elimination of like-kind exchanges would have serious consequences. Thousands of owners of commercial property would face an increased tax burden. The authors estimate that investors would need to raise rents on residential properties by nearly 12 percent to ensure a rate of return similar to the return available by using a like-kind exchange.
Abstract : “The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate” is a first-of-its-kind study that analyzed more than 1.6 million real estate transactions over an 18-year period. Study authors, Milena Petrova, professor of finance at Syracuse University’s Martin J. Whitman School of Management, and David Ling, finance professor at the University of Florida’s Warrington College of Business, found like-kind exchange rules have led to a more dynamic real estate sector by encouraging increased investment and reinvestment activity, allowing real estate owners to better allocate resources and decreasing levels of debt in commercial and multifamily real estate transactions. Among the study’s results is quantifying the link between like-kind exchanges and increased investment. On average, a taxpayer using a like-kind exchange acquires a replacement property that is $305,000 to $422,000 more valuable than the original property – additional value that is invested into the community. Likewise, the study shows properties acquired through like-kind exchanges are more likely to undergo building improvements and expansion, ultimately creating more jobs.
Elimination of like-kind exchanges would have serious consequences. Thousands of owners of commercial property would face an increased tax burden. The authors estimate that investors would need to raise rents on residential properties by nearly 12 percent to ensure a rate of return similar to the return available by using a like-kind exchange.
The study also finds that in nearly 90 percent of the cases, taxpayers using like-kind exchanges did not defer paying tax indefinitely, as some critics charge, but paid substantially more in tax when the property was sold than would have been due had the exchange not occurred. Removing the exchanges would decrease property values and net investment, increase holding periods, and increase the use of leverage to finance acquisitions. These micro effects are likely to have macro-economic consequences as well by decreasing construction and investment activity in commercial real estate markets, which would depress employment in markets where like-kind exchanges are commonly used. It is critical to fully understand the positive economic effects of the like-kind exchange provision before considering any changes to the policy.
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Like-kind exchange rules encourage increased investment and reinvestment activity, allowing real estate owners to better allocate resources and decreasing levels of debt in commercial and multifamily real estate transactions.
