Like-Kind Exchanges: Highlights from California

This blog post was written by Erin Fitzpatrick. Erin is a Summer Research Intern and is currently studying at George Washington University pursuing a B.S. in Economics and a B.A. in Political Science.

The latest data from Bureau of Economic Analysis[1] shows that the Real Estate Industry accounted for $366.6 billion in California. This constitutes around 16 percent of the Gross Domestic Product of real estate in the United States. With the eighth largest economy in the world[2] and a significant portion of the real estate market, one must look at how policy changes will disrupt California’s market.

Internal Revenue Code (IRC) Section 1031—governing like-kind exchanges—is an important feature of the tax code, which enhances real estate transactions, thus positively impacting California’s economy. Like-kind exchanges (LKE) can be utilized by individuals, partnerships, corporations, limited liability companies, and trusts. IRC Section 1031 allows investors to defer taxes when disposing of property, as long as the proceeds are reinvested in another property of like kind within 180 days. This tax deferral feature allows increased investment in properties and encourages a more active real estate market.

The Like-Kind Exchanges: Real Estate Market Perspectives 2015 report provides information about LKEs and their impact on real estate markets. The report is based on a national survey of both commercial and residential REALTORS®. In California, about 75 percent of respondents who indicated that they participated in an LKE transaction from 2011-14 engaged in 1 – 6.  In addition, LKE transactions in California involve properties held for a longer duration, with 39 percent being held for 5 – 9 years and 27 percent held for 10-14 years.

Like-kind exchange transactions lead to additional investment in real estate properties, as over 90 percent of respondents from California indicated. The majority of California’s respondents, 59 percent, stated that the average capital investment in property improvements is between 10% - 24% of the property’s fair market value. The additional capital spending helps create jobs and increases the Gross State Product of California.

Respondents to the survey were asked how the repeal of IRC Section 1031 would change the real estate market. 89 percent of respondents stated that, without the tax deferral provision, real estate values would decrease. 97 percent of respondents also stated that there would be a decrease in demand for core assets/business/service if repeal were to occur.

To access the Like-Kind Exchanges: Real Estate Market Perspectives 2015 report, visit http://www.realtor.org/reports/like-kind-exchange-survey.

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[1] U.S. Bureau of Economic Analysis, “Gross domestic product (GDP) by state (millions of current dollars)” http://www.bea.gov/iTable/iTable.cfm?reqid=70&step=1&isuri=1&acrdn=1#reqid=70&step=10&isuri=1&7003=200&7035=-1&7004=naics&7005=1&7006=04000&7036=-1&7001=1200&7002=1&7090=70&7007=2014&7093=levels (accessed July 30, 2015)

[2] Masunaga, Samantha. "We're No. 8: California near Top of World's Largest Economies." Los Angeles Times. Los Angeles Times, 2 July 2015. Web.