Commercial Real Estate Needs Help Stabilizing

Eliminating 1031 like-kind exchanges would hit mom and pop investors hardest and cause a devastating domino effect on the economy.
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This article was updated on Oct. 13, 2020.

Thanks to forbearance and other emergency benefit programs, the residential real estate market is holding strong during the pandemic. Millions of Americans are actually seeing their home values increase. This brings a great sense of security to families and a much-needed dose of confidence in the economy.

But not all real estate is equal.

Because of the pandemic, tens of thousands of American small businesses have permanently shuttered, nationwide unemployment rates remain near 8%, and a full economic recovery still appears months away. As a result, new tenants are in short supply, commercial real estate is hemorrhaging, and the effects are impacting commercial property values across the country.

We don’t need a history lesson from the 2008 housing crash to know how devastating a domino effect can be to real estate and the overall economy.

Without further intervention, the situation could go from bad to worse. With punitive and misguided new policies, it could go from worse to catastrophic.

One of the pillars of commercial real estate is the 1031 like-kind exchange, which allows investors to defer paying taxes on the sale of real estate if the money is immediately reinvested in another productive property.

The myth of the indefinite exchange to avoid taxes is just that—a myth.

Some believe like-kind exchanges are used only by the super-rich and think closing this so-called “loophole” would create an easy pot of gold at the end of the rainbow. So, let’s bust a few myths about who uses Section 1031 and whom it benefits.

Recent data shows that only 5% of exchanged properties are held by regular corporations. The vast majority are actually held by mom and pop investors—sole proprietors and pass-through businesses such as partnerships and S corporations.

A 2015 study further revealed that 88 percent of exchanged properties were later disposed of through a taxable sale. And taxes paid are 19-percent higher when a property is exchanged then sold versus never having been exchanged.

The myth of the indefinite exchange to avoid taxes is just that—a myth.

Allowing investors a free flow of capital allows them to buy into higher-priced and more productive properties which creates more tax revenue—and job opportunities and growth.

The idea that repealing 1031 would raise revenue is a pipe dream. The great majority of properties now swapped under the like-kind exchange would not be sold if tax was due. Rather, their owners would continue to sit on the property, and the growth opportunity for putting the investment to better use would be wasted with the government collecting little in extra revenue.

Beyond the preservation of 1031 like-kind exchanges, other types of assistance are needed to prevent the collapse of commercial real estate.

More initiatives like PPP will help small business owners outlast the pandemic and pay their bills and workers.

Other actions like remote online notarization help stabilize the industry and grease the wheels of commerce. This innovation is so far covered in a patchwork of state rules, but a uniform approach nationwide could be critical during the pandemic.

The real estate industry makes up nearly one-fifth of the entire American economy, and access to property ownership in the U.S. is the envy of the world. Any policy to weaken this foundation harms the economy at a time when we need to deploy every tool possible to support it.