COMMENTARY: A recipe for economic stagnation
An essential tool in rebuilding the commercial real estate economy of Las Vegas and Nevada — still reeling from the ravages of COVID-19 — is at serious risk as part of the $1.8 trillion American Families Plan being considered in Washington.
The $1.8 trillion plan presented by President Joe Biden proposes to cap at $500,000 the amount of gains that can be deferred from the sale of property.
This shortsighted and counterproductive cap is a recipe for economic stagnation, not recovery.
For the past 100 years, Like-Kind exchanges under Section 1031 of the Internal Revenue Code have allowed sellers of commercial properties to defer taxes when the proceeds from the sale are reinvested into new properties. This reinvestment tool has been a cornerstone of the U.S. commercial real estate market, generating economic benefits on every level that far exceed the amount of taxes deferred.
Every community in the nation, including here in Las Vegas, Reno and the rest of Nevada, have witnessed the closing of countless shopping malls, strip centers and restaurants because of the pandemic. The fallout continues in hotels and office buildings. Virtual meetings could potentially permanently replace significant business travel, and many people will work from home exclusively.
A substantial effort to repurpose these properties and redevelop commercial spaces will be required for the economy to regain its strength. Willing investors would be crippled without the ability to defer taxes and reinvest in commercial properties.
1031 exchanges provide fundamental liquidity to real estate, spur the redevelopment of distressed properties, finance the construction and renovation of multi-family and affordable housing and generate significant revenue for state and local governments through property taxes, transfer taxes and recording fees. And it is essential to stress that a 1031 exchange is a deferral, not an avoidance or elimination of tax, as taxes are paid over a 15-year window.
The Federation of Exchange Accommodators, the national organization of 1031 exchange companies, analyzed the data from seven companies in Nevada between 2015 to 2019 and found 6,827 properties involved in exchanges that generated $56.1 million in state and county transfer taxes and recording fees. This is just a portion of the market here, as there are many more companies that facilitate exchanges.
A 2017 macroeconomic study by Ernst &Young, recently updated, concluded that if section 1031 were limited or repealed, it would shrink GDP. The study further projected benefits from 1031 exchanges for 2021 and concluded that, on a national basis, these transactions will support 568,000 jobs, representing $27.5 billion in labor income and generating $5 billion in federal income taxes; generate $6 billion annually in federal taxes from foregone depreciation on replacement properties; generate $2.8 billion in state and local taxes; and add $55 billion to the GDP.
Just the $5 billion generated from the jobs in one year far exceeds the estimate in the 2021 Biden budget that says capping 1031 at $500,000 raises on average of $1.95 billion per year over 10 years. Why would anyone change section 1031? It doesn’t raise any money.
In addition, all of the capital gains get paid at the end of the investment in roughly a 15-year window. Eighty percent of the taxpayers do one 1031 and then sell in a taxable sale. It’s a win-win.
The resurgence of our economy will need to be generated from many sources, and the private sector must again play a significant role in the recovery. The best way to encourage improvements and strengthen this infrastructure stock is to keep section 1031 unchanged to encourage investment and most importantly, reinvestment in the real estate economy.
Kenneth N. Blomsterberg is senior managing director of investments for Marcus &Millichap in Reno. Daniel Wagner is senior vice president of government relations for The Inland Real Estate Group of Companies.
