Dispelling common myths about Section 1031 as we prepare for possible legislative action.

In Part I of our blog series on 1031, we tackled some of the most common myths about the program. In Part II, we’ll address more misconceptions and explain some benefits of Section 1031 you might not be aware of.

Here are some more things you may have heard about 1031 and its economic, environmental, and social impact, and why the facts tell a different story.

Myth #4: “1031 Exchanges Raise the Price of Real Estate and Don’t Create Affordable Housing.”

While 1031 can be used for large-scale commercial properties, it is also used for smaller multifamily and even single-family residences. Roughly 40% of investment in like-kind exchanges goes toward rental housing. The tax benefits of a 1031 exchange can help investors and building owners lower their overall cost of capital, and this savings can get passed on to renters in the form of lower rental costs.

Exchanges can also fill gaps in the housing supply not covered by other incentives. In order to expand workforce housing, the investment of private capital is required, but incentives like the Low Income Housing Tax Credit do not apply to land acquisition costs, slowing the development of new housing. Without 1031, the cost of creating new housing would be greater, and therefore owners would have to raise rents significantly.

Myth #5: “1031 Promotes Development and is Therefore Bad for the Environment.”

1031 exchanges can encourage property development, but that doesn’t automatically mean they harm the planet. Farmers, ranchers, and forest owners rely heavily on like-kind exchanges in order to keep those properties in use for their intended purpose. They can also use like-kind exchanges to combine acreage, acquire higher-grade land, mitigate environmental impacts, and improve the quality of their operations.

Land conservation organizations rely on 1031 to preserve open spaces for public use or environmental protection. Land conservation transactions often involve the exchange of environmentally-sensitive areas for other less sensitive privately-held property. These transactions protect environmentally-significant land while enabling private landowners to preserve capital for expansion or diversification of existing operations.

1031 is supported by organizations such as the Conservation Fund, the Nature Conservancy, the Land Trust Alliance, and the American Farm Bureau Federation, so the idea that it’s simply a tool of big business or Wall Street is absolutely false.

Myth #6: “1031 Doesn’t Stimulate the Economy.”

An assumption that there is no societal economic benefit to 1031 simply isn’t supported by the facts: exchanges increase investment, create jobs, lower rents, and support the growth of property values, which in turn means more tax revenue.

A recent report from Ernst & Young estimates that like-kind exchanges could support the employment of 568,000 workers earning $27.5 billion in wages and benefits, and generating $55.3 billion in added value in 2021 alone. This includes both direct jobs and those indirectly supported by exchanges, including jobs for architects, designers, building material suppliers, movers, maintenance and cleaning staff, security, landscapers, qualified intermediaries, real estate brokers, title insurers, escrow agents, attorneys, accountants, lenders, property inspectors, appraisers, surveyors, insurers, and contractors.

These economic benefits are especially important during the recovery period from the COVID-19 pandemic. Exchanges can help accelerate recovery by preventing properties from languishing and being underutilized. Tax deferral spurs real estate transactions, getting properties into the hands of new owners with the time, resources, and desire to restore and improve them. The pandemic has shifted needs for many businesses, meaning properties must be repurposed; 1031 allows for the investment necessary to get these properties into shape so businesses can address the realities of post-COVID life.

Now more than ever, investment is important for stimulating the economy, and 1031 encourages that investment. Plus, because of the program’s strict rules, investors must quickly purchase a replacement property rather than wait for the market to rebound, which encourages market stabilization.

Hopefully, this analysis will help you cast a more critical eye on some of the common complaints regarding 1031. Statistics show just how beneficial the program has been and why it needs to continue. The more average investors understand 1031, the more they can support and take part in it.

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