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April 14, 2016

Eliminating popular tax deferment could chill the real estate investment market


By Greg Frick, HFO Real Estate Investment

Tax-deferred exchanges of certain property types have been a part of the Internal Revenue Code for more than 80 years.
I've been in the commercial real estate industry for 23 of them, and for the first time, I'm seeing some of our clients actively making acquisition and disposition decisions based on the possibility that 1031 exchanges may disappear in 2016.

When initially created, 1031 exchanges were meant to avoid unfair taxation of ongoing investments and encourage active reinvestment. Both of these purposes remain equally relevant today and continue to benefit a wide-ranging spectrum of taxpayers. They also effectively help stimulate the U.S. economy.

Yet, over the last 20 years, there have been multiple bills introduced in Congress in favor of eliminating IRC 1031, and at least three proposals since 1991 have been brought before the Oregon State Legislature in favor of changing, limiting or repealing IRC 1031 like-kind exchanges.

The most recent proposal was in April 2013, when Oregon House Bill 3433 proposed taxing 1031 property exchanges. The bill, like all the others, failed.

Now, both parties of Congress are proposing to completely eliminate or dramatically change 1031 like-kind exchanges for 2016, making it the first time a proposal of this nature has earned bipartisan support. The timing is simultaneous with the Obama Administration's 2016 budget proposal, which limits the amount of capital gain that can be deferred on like-kind exchanges to $1 million per taxpayer per taxable year (indexed to inflation).

I believe this proposal is bad public policy because an active commercial real estate market results in higher property values, increased property taxes for municipalities, and it impacts economic growth in nearly every sector of the economy.

According to a March 2015 report by Ernst and Young titled “Economic Impact of Repealing Like-Kind Exchange Rules” and prepared on behalf of the Section 1031 Like-Kind Exchange Coalition, the long-run impacts of this change are as follows: GDP is estimated to fall by $8.1 billion each year ( a .04 percent decline); investment is estimated to fall by $7 billion ( a 0.18 percent decline), and labor income is estimated to fall by $1.4 billion (a 0.11 percent decline).

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