I’ve been in the real estate business in California for nearly four decades. My younger brother Kevin and I followed in our father’s footsteps, joining the business he created in 1964. I now focus on selling apartment buildings to institutional and private capital investors, as well as maintaining our own family portfolio.
And while our success over the years can be attributed to many things, one very important factor is the like-kind exchange rule — a key provision in the tax code that allows for the trading of one business or investment asset for a similar property. In place since 1921, many of these exchanges involve real estate. They’ve proven an essential and effective engine to fuel our economy, allowing investors to defer capital gains into a similar investment and encouraging them to reinvest, hire employees and expand operations.
Like-kind exchanges are particularly important for Californians: our state accounts for nearly 40 percent of all such trades. And because taxes are higher in California than in most states, like-kind exchanges are even more significant. Without them, rents would be higher, perhaps by as much as 40 percent. That could make or break many Golden State residents trying to make ends meet.
In the Bay Area, roughly 13 percent of commercial real estate transactions involve a like-kind exchange, compared to 5 percent nationally. Additionally, cities that have transfer taxes — or taxes on the transfer of a title to property — depend heavily on the income from like-kind exchanges. In Oakland, for instance, if someone completed a like-kind exchange totaling $10 million, the city would make $150,000 in transfer fees.
When I started in the real estate business in the late 1970s, I acquired two four-plex apartment buildings. Through 1031 tax deferred exchanges, the equity from those four-plexes is now part of a 72-unit apartment building. The growth of our family business and the reinvestment back into the local economy would not have been possible without the like-kind exchange.
To put a finer point on it, if like-kind exchanges are limited or repealed as the Obama administration and some in Congress have proposed, I simply wouldn’t be able to do another real estate deal. Period.
In a recent study by Dr. David Ling of the University of Florida’s Warrington College of Business and Dr. Milena Petrova of Syracuse University’s Whitman School of Management, the authors examined 1.6 million real estate transactions over 18 years. They found that eliminating or limiting like-kind exchanges would have severe economic consequences.
Property owners, like my brother and I, trade our equity into new properties. Without like-kind exchanges, the effective tax rate on those investments would grow from 23 percent to 30 percent — a nearly impossible economic proposition. In addition, in order for commercial properties to generate the same rate of return, prices would have to decline to maintain required equity returns.
What’s more, investors would no longer reinvest capital gains into new properties in their communities. As a result, they would have to borrow more money or walk away from needed projects. And, with less money available for improvements and expansions, fewer jobs would be created and property values would decline. That’s not only bad for folks like me, it’s bad for California workers, state and local governments and the overall economy.
While I appreciate the Obama administration and members of Congress taking a hard look at our tax code to make it work better for all Americans, like-kind exchanges should not be among their targets. For nearly a century, this provision has served as a vehicle for economic growth, job creation and reinvestment; it has helped small business owners like me succeed, invest and save for my family’s retirement.
This isn’t about Washington economic theory. It’s about real-world economics. And by any measure, like-kind exchanges work and should be preserved for the long term.