1031s Prove Their Worth

What would really happen if legislators did away with the Section 1031 Like-Kind Exchange in an attempt to raise federal revenues? As commercial real estate professionals know, such a move would have the opposite of the intended effect, stifling economic activity and ultimately eroding GDP. And yet, the 1031 is perennially under threat, says Evan Liddiard, CPA, director of federal tax policy for the National Association of REALTORS®. That’s primarily because many legislators and their staff see the provision as a giveaway to the wealthy; they don’t have a clear understanding of why tax-deferred exchanges exist or how they work.

NAR is part of a coalition that helped preserve like-kind exchanges of real property during negotiations for the 2017 Tax Cuts and Jobs Act. That coalition has been on high alert since candidate Joe Biden proposed repeal of 1031s as a way to fund certain social programs. And although getting COVID-19 under control has been Job One for the Biden administration, the president’s tax plan is likely to surface in the spring or summer. “We have to
continuously work on educating Washington about the 1031,” says Liddiard.

In late 2020, NAR and its coalition partners began that work anew, updating research that was used back in 2015–2016 to help dispel the myths and demonstrate the benefits of 1031s. However, nothing is more powerful in the eyes of elected officials than real-life examples in their home states, Liddiard says.

REALTORS® are in a great position to share those examples: A majority of REALTORS® working in commercial sales helped to facilitate at least one 1031 exchange in the past several years, according to NAR. Two 1031 success stories, recently published in REALTOR® Magazine and excerpted here, demonstrate the benefits that can accrue to businesses, individual investors, and communities.

Success Story 1: Shiny New Anchor

When a grocery chain pulls up stakes, the results can ripple through a community for years. That situation began in 2013, when Safeway announced it was closing its Dominick’s Finer Foods stores in the Chicago market, including three locations in suburban Naperville, Ill.

One of those Dominick’s properties anchored a shopping mall called Fox Run Square. “Grocery stores are probably one of the safest types of anchored shopping center,” says Christine Jeffries, president of the Naperville Development Partnership. But the older centers “tend to get dog-eared and need reinvestment and modernization.” The owners may not have money to sink into improvements; at the same time they may be ready to sell it and realize a big capital gain. “So, they just sit on the property.”

The 35 investors in Fox Run Square didn’t want to do that. They strategized with Rahul Sehgal, chief investment officer at Inland Private Property Corp., and sold the mall to Bradford Real Estate Corp. for $25.6 million in 2014. By using a 1031 exchange, the investment group was able to defer capital gains taxes. Without the exchange, the investors would have held onto the property and tried to renegotiate with the bank, says Sehgal. “Our investors did not have the nearly $30 million of additional capital that the developer spent. Even if they had come up with that kind of money with our assistance,
that property would have sat vacant for a long time.”

The deal led to the construction of a new Mariano’s grocery store on the Dominick’s site in 2016. Most of the mall’s tenants, primarily small businesses, stayed on, continuing the employment and services they had long provided the community. “It’s about keeping and supporting the small businesses,” Sehgal says. “You can’t support them unless you have an anchor, no matter how loyal a base they have.” The two other former Dominick’s properties in Naperville followed a different trajectory. After both were leased by Albertsons Companies, one was still unoccupied in 2020, and the other only recently became home to an Amazon Fresh store. Jeffries said the dark buildings took a toll on the community. “We started seeing a lot of vacancies [nearby]. Albertsons was paying rent, but there wasn’t the same traffic, the same vibrancy you would have had if a grocery store had
occupied there immediately.”

Success Story 2: Farm to Table

In 2014, Craig Fernsler’s 95-year-old client sold a farm in Williamsport, Pa., to a company that wanted to build a plant there. Of the $4 million purchase price, a little under $2 million had gone into a passive investment for her.

She wanted to put the remaining funds into a replacement property but didn't know how. “My immediate goal was to find out the client’s and her family’s risk tolerance and what they were really looking for,” says Fernsler, CCIM, senior director at KW Commercial in Blue Bell, Pa.

What Fernsler found, and the family chose, was an investment in a new corporate-guaranteed Wendy’s fast-food restaurant in Chicago. “There were minimal risks,” Fernsler says. “This was a new 15-year lease with increases in rent that Wendy’s would pay my client. And Wendy’s would take care of snow removal, lawn care, and any repairs and maintenance. The [client’s] kids knew this Wendy’s would be staying in business.”

The Wendy’s was built on the site of a dilapidated warehouse. When it was determined that the groundwater and soil were contaminated, the developer hired a company to oversee removal of the storage tank and collect samples for testing. Eventually, more than 4,200 tons of soil were removed
and disposed of in accordance with environmental safety requirements.

“Nobody was working in that run-down warehouse for years,” Fernsler says. The restaurant brought employment and drew more people to the area, creating more activity and traffic to nearby businesses. In addition, Fernsler says. “I worked with an attorney and a title company. The developer hired people to construct the building. Engineers were hired, as well as a surveyor, an attorney who took the project through the approval process with the municipality, and the municipality attorneys. Everybody that touched this was paying regular income taxes. And transfer tax was paid when the transaction happened. This kind of transaction creates a chain reaction, but if you take away 1031s, the chain breaks.”