Study Highlights Importance of Like-Kind Exchange Rules for New Residential and Commercial Properties

A new study, “The Economic Impact of Repealing or Limiting Section 1031 Like-Kind Exchanges in Real Estate,” highlights the critical role that the tax code’s like-kind exchange rules play for the real estate sector, as well as the construction of new residential and commercial properties.

Like-kind exchange rules allow taxpayers to defer tax when they exchange one property held for investment or business use for other property of a “like kind.” These rules promote savings and investment, allowing capital to flow freely and efficiently—ensuring its best use, encourage commerce and ultimately stimulating economic growth and job creation.

The study analyzed more than 1.6 million real estate transactions over an 18-year period. Among all commercial real estate transactions, multifamily-related sales recorded the highest use of like-kind exchanges based on both unit and dollar volumes.

Among the key findings:

• Like-kind exchanges encourage investment. On average, taxpayers using a like-kind exchange acquire replacement property that is $305,000 - $422,000 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% 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% reduction in borrowing, or leverage, at the time of the acquisition.

An important conclusion of the analysis found that in 88% of cases, taxpayers using like-kind exchanges did not defer paying tax indefinitely, as some critics charge. In fact, they paid substantially more in tax (19%) when the property was sold than would have been due had the exchange not occurred.

The research was authored by David Ling of the University of Florida and Milena Petrova of Syracuse University, with financial support from the Real Estate Like-Kind Exchange Coalition, which is comprised of organizations representing all sectors of the real estate industry, including NAHB.

• Read more analysis in New Study Highlights Importance of Like-Kind Exchange Rules, Eye on Housing, July 10, 2015
• Access the full study.