Like-kind exchanges are an excellent vehicle for deferring capital gains taxes.
Also called a 1031 exchange, like-kind exchanges allow investors to sell a commercial investment property and reinvest the funds into the purchase of another property of equal or higher value.
Short-term capital gains taxes – taxes owed on a property you’ve owned for a year or less – add up to between 10% – 37%; owners pay 10%-20% on profits made from the sale of a property owned for more than a year.
All in all, like-kind exchanges can mean you save as much as 39% in capital gains taxes due to the sale of the property.
Like-kind exchanges also allow you to defer depreciation recapture, which can add up to an additional savings of up to 25%.
With these numbers, there’s no question that like-kind exchanges offer numerous advantages for the savvy investor. Surprisingly, it’s not just the individual investor that benefits from like-kind exchanges.
Why Some Lawmakers Are Against Like-Kind Exchanges
Although 1031 exchanges are very common, it is hard to estimate the value of these exchanges.
When you add this difficulty to the fact that many people question why investment properties are eligible for like-kind exchanges, while other types of investments, such as stocks and bonds, are not.
Like-Kind Exchanges Keep Deals Flowing
A recent study showed that 1031 exchanges actually encourage business growth.
That’s because businesses have the option of selling an under-performing asset, which allows them to invest their money into a higher performing property.
Selling an investment property lowers the level of debt and makes it easier for investors to allocate funds more effectively.
Like-Kind Exchanges Encourage Business Growth
If the owner of the property is a business, selling the property could allow them to build equity, reduce third-party financing, or raise needed funds through a sale-leaseback.
These extra funds can then be utilized by the business to reinvest in the business, which helps create new jobs and gives a boost to the economy.
Without like-kind exchanges, businesses would be forced to hold onto properties that no longer serve their needs, which in turn would cause a greater reliance on debt financing.
Like-Kind Exchanges Stimulate Growth In a Variety of Industries
A successfully executed 1031 exchange requires a number of people in a wide variety of professions.
Aside from the investor and the broker who performs a 1031 exchange, there are lenders, title insurers and contractors. Both the original property and the replacement property will need to be renovated by their new owners, and new equipment will need to be purchased and installed.
This means that numerous industries, both locally and nationally, will benefit when a like-kind exchange takes place.
Eliminating Like-Kind Exchanges Would Disrupt Market Values
Other studies have shown that increasing capital gains taxes means investors end up being less willing to pay higher prices for commercial properties.
Moreover, if the cost of purchasing a replacement property is well over what an investor would receive from the sale of the original property, this would affect overall market values as well.
In cities with lower taxes, market rates could be affected by about 8%; highly taxed states could see up to 17%. Both are likely to disrupt market prices in many commercial real estate markets.
In order for the market to recover, construction of new properties would need to decrease, the demand for leasable space would need to increase, and other properties available for lease would need to become obsolete – all of which take time.
Thus, as studies show, rather than cost the government money, like-kind exchanges positively affect a variety of industries, and contribute to the GDP.
If you want to learn more, please do not hesitate to contact Westwood by filling in our online application form. Some of our agents will soon reach you out.