91: Proposed Tax Policy Changes Webinar

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This is Real Estate Investing Live from New York with James Nelson, the principal and head of Avis & Young's Tri State investment Sales Group. In this program you'll learn about the world of commercial real estate and find out why it's one of the largest investment opportunities in New York and around the world. Now here is your host, James Nelson.

Welcome to episode number 91 of Real Estate Investing Live from New York. This is your host, James Nelson. I am principal and head of Tri State Investment Sales at Avis and Young. Thank you as always for joining. It means so much to me your support. And if you did not listen to the episode last week which I entitled Best of the Young Guns we went through and there are about half a dozen of the interviews from some of the young up and comers who talked about their keys to success. If you didn't give a listen, definitely go back and check that out. I also announced the launching of JamesNelson.com and yes, we are live with this. This is the resource hub for you. As the landing page says, this is to help you gain the insider's edge to real estate investing and that's what this show is certainly all about. You can go there to not only get all the podcasts with the show notes there, but also the white papers that I write monthly on what to be thinking about when investing. There's also an exclusive video series that you can sign up for which will take you through step by step how to make the best real estate investments. There's a resources page where you can find key terms and also recommended podcasts and books. So there's just so much information. It would mean so much to me if you could go to jamesnelson.com and you could sign up to get my newsletters in the future and updates from that site. So please give it a look@jamesnelson.com and I love your feedback as always and questions. Amesnelson NYC whether it is on LinkedIn, Twitter or Instagram. Okay, so for today's show, and as you know we typically have investor spotlights, but it's also very important for you all to understand what's going on in the world and the proposed federal tax policy, the changes in the impact on commercial real estate are going to be massive. I know this can potentially be a dry or tough subject, but this is information that you have to know. If you are investing in commercial real estate right now and you do not know what is being proposed down in Washington. This is a must, must. Listen. I have on this panel Ryan McCormick who is the senior VP and counsel for the Real Estate Roundtable. They are the most powerful organization representing the real estate industry down in Washington for these initiatives, changes that affect us across the country. And then I also have Ken Weisenberg and Lisa Nee, they're co heads of Eisner Ampers real estate practice and they're going to be dissecting at least four of the major considerations as far as changes that are being proposed to the tax code, capital gains carried interest, the potential elimination of a stepped up basis and of course the 1031 and will it survive. So we're going to have a brief word from our sponsor and we'll get right back into this panel. And please remember to share this with your friends as this is definitely information that you you need to know. Thanks again.

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Great. All right, so we're at the top of the hour. I probably do want to go ahead and get started just because I know there's going to. I want to leave time for questions and everything. So we'll go ahead and get started. So welcome everyone. I'm James Nelson. I'm principal and head of Tri State Investment Sales for Avis and Young. Thank you so much for joining us today for this very important conversation that we're having on tax policy and how this is going to impact commercial real estate. This is the issue as I'm speaking to many of you today to find out what is on your mind. And certainly with us today we've got an incredible panel. So joining us is Ryan McCormack who is senior Vice President and Counsel at the Real Estate Roundtable where he is responsible for managing the organization's tax policy activities. Ryan coordinates the activities of their Tax Policy Advisory Committee, a group of 150 leading real estate tax experts, including the in house Tax directors, general counsel, CFOs for their members. Prior to joining the roundtable in May 2013, he served nearly 11 years in the U.S. senate as a tax and economic policy advisor for Senators Bob Graham, Pat Moynihan and John Kerry, among others. So welcome Ryan, thank you so much for joining and all that you do. I also want to welcome to the stage Kenneth the Virtual Stage. Kenneth Weisenberg and his partner Lisa Ni. They are the tax partners and co leaders of Eisner Ampers national real estate practice. Ken's expertise encompasses all aspects of the real estate industry ranging from developing tax saving strategies for owners and operating property to structuring and negotiating complex sales, acquisitions and financing transactions. Ken has been involved in over $50 billion of real estate transactions over the last 30 years. Lisa is also tax partner and co counsel again of the real estate practice and is a leader of their private equity group with over 25 years experience. Her experience covers a range of real estate fund and transactions including acquisitions refis like kind exchanges which we're certainly going to be talking about today, JVs structuring. And she has received many notable awards including from Crain's New York Business as one of the most notable women in accounting and consulting. So welcome Ken and Lisa, thank you for joining us. So I think for today and would love to set the stage if Ryan could help us do that with what is going on down in Washington because we are all watching this very closely. And then Ken and Lisa have prepared a deck for us where we will be be able to kind of go through the four major issues as far as I see it and maybe you all will add to this. But on my mind is what's happening with capital gains, the potential elimination of the 1031, what is happening with carried interest tax and then the potential loss of the stepped up basis. Those are four issues that we're certainly going to be covering on this today amongst others. But Ryan would love for you to fill us. What the what's taking place down in Washington. I know there's an emerging proposal that's happening right now there with Senate Democratic leaders. They're trying to figure out how to pay for Biden's $1.2 trillion infrastructure agenda. Senator Majority Leader Chuck Schumer is also planning to pass a budget under reconciliation. So there's a lot going on and I know everyone listening wants to know what is in store here and how and when this is going to take place. So hoping you brought your crystal ball with you for today. And Ryan. Yeah, please. And what you're seeing down there.

Thanks, James. Absolutely. And happy to try and address those questions. First, let me just say thank you. A real honor to be on today with your have a tremendous reach and visibility into real estate markets. And we learn a lot at the roundtable from the work that you all are doing and the information that you all put out for us. And others also just want to say it's real honor to be on with Ken and Lisa as well from Eisner Amper. They obviously have tremendous knowledge and awareness of what's going on on the transaction side and commercial real estate. And we also learn a lot from them that helps guide our efforts on policy in Washington. Let me just step back for a second if I could, James. I think it's important to remember that this is all we're going to focus obviously on the tax issues for the next 30, 40 minutes or so. But this is not happening in a vacuum, the tax conversation. It's really happening in the context of a much broader debate and discussion over big, big policy, fiscal spending, infrastructure, housing climate, economic equality, inequality issues, all of which are getting kind of balled up into one big debate this summer and fall. I know a lot of our audience is real estate owners. I just say there are a lot of implications to what's likely to happen over these next few months beyond just the tax. That's going to have a big impact on real estate, on property values, on property markets. And we have a saying at the roundtable, where goes infrastructure, so goes real estate, and vice versa. Nothing is more important to kind of the economics of real estate than the surrounding infrastructure. So we're a CEO level organization. Our members are really heavily focused on the broader picture and what that's going to mean for economic, income and infrastructure and all types of activities going forward. You know, that, that said, you know, I focus specifically on the tax issues. That's the topic of the day here, and rightly so. You know, President Biden during the campaign put forward really ambitious proposals. He's kind of followed through on those and putting them forward in the context of his American jobs plan and American families plan. All of those proposals are part of the presentation that Ken and Lisa are going to walk through. But I just say the mere fact that they are included in the president's budget in a Washington that is Democratic controlled, with a Democratic Congress controlled, both the Senate and the House by Democrats really means these proposals, I think, are the starting point and need to be taken very, very seriously. So any changes from the president's plan are really going to be because Congress looks at the economics of these changes and decides that, you know, that they're not the kind of thing that we should be pursuing. My conversations on the Hill right now, I think there's a real strong recognition that the pandemic hit commercial real estate very hard. That's obvious. We all saw it. Stores closed, shopping malls, shopping centers, office buildings have been heavily affected. Hotels, particularly those business hotels. That said, I also think policymakers understand that commercial real estate really stepped up over the last year. And we did a number of things to really, I think, ameliorate and really help our tenants, particularly restructuring leases, particularly, you know, on the retail side. We've seen Roundtable members and other real estate firms kind of step forward to help their tenants on the commercial side with kind of big taking interest and including equity interests and big national retailers. That's helped keep a lot of a lot of our retailers afloat. And we've helped kind of facilitate the reopening process. We've done a lot of work to try to keep the buildings clean as well and safe. So I think we have some goodwill going into this debate. Real estate also traditionally is a big driver of growth coming out of recessions. And that's what we had. We had a very deep recession, short, but very deep. And real estate is going to be a big driver there. That said, we strongly believe that if you were to adopt really structural changes to the tax code that impose heavy costs and really skew and distort the economics of real estate investment and real estate finance, that's going to have a negative impact. That's the backdrop. I just wanted to establish that. But let me briefly address your questions because top of mind for everyone is what's about to happen and where are we? Breaking news yesterday evening, which is that basically Senator Schumer and Budget Committee Chairman Bernie Sanders and the Budget Committee Democrats kind of reached an agreement on a budget resolution. So budget resolution is just a framework. It doesn't set the tax policies. It sets the top line numbers. But those are really important numbers because people care deeply about how much deficit spending we're going to do, how much tax increases we're going to do. And so that basically paves the way, I think, for them to move forward with this two track approach of a bipartisan infrastructure bill and a reconciliation bill these next few weeks. I think we're going to have the budget resolution and infrastructure plan come out of the Senate, but that's not the end of the process. They'll still have to go through the House and then we still have to actually write the tax bill. The reconciliation budget resolution is not the tax bill. Bottom line, I've gone back and forth on whether I think this is likely to happen or not. At the end of the I'd say right Now I'm probably 60 to 70% view that they're going to pass both bills, a big reconciliation bill that includes a lot of social spending and tax provisions, as well as an infrastructure bill. But there's a lot of twists that we're going to go through before we get there. I think members of Congress think. I think the Democrats think failure is not really an option here. Much like Republicans after they were unable to repeal Obamacare, they felt like they really had to do tax reform and they had to get it done and they did it. I think Democrats are very united in getting something done here. They have very tough margins. One vote in the Senate, two or three in the House. So they have no room for failure. But my guess would be they stick together and we end up with a pretty significant tax bill at the end of the day.

Stage. And by all means, you know, we need that macro picture before we really talk about the implications for real estate. I want to dig in a little bit more about the makeup of Congress because as far as how these bills could potentially be passed. And you know, you hear about, well, if reconciliation takes place, then the GOP effectively could not block a bill of that nature. And you already alluded to the fact that the Senate is basically deadlocked. I mean, you hear Joe Manchin has been very vocal and certainly there's a lot of moderates on the Dem side. But how do these bills actually get passed and what is the timeline? I mean, you hear a lot of fear out there also about, you know, could this even potentially be retroactive what they're talking about? So yeah, maybe you could just tell us how these decisions are ultimately going to get made. You know, could the gop, if they all join forces, could they block this or will reconciliation ultimately allow the Democrats to pass this as they see fit?

Yeah. So Republicans have basically said no tax increases in this bipartisan infrastructure bill. So that pushes everything tax wise into an all a partisan process where they're going to rely fully on Democratic votes to do revenue provisions and other things. What does it mean that the margins are so small everyone has enormous leverage if someone decides they have to have something or they're not voting for the bill, then they have to get makes it very difficult for people like Leader Schumer or House Speaker Pelosi to navigate these. But I do think there is a desire and a recognition that they hang together or hang separately. I do think that they can bridge those differences. But it's also going to require a lot of presidential leadership. I mean, I think Biden really has to President Biden really is going to have to lead and get the progressives and the moderates and everyone kind of on board with the same approach. I think it means it's less ambitious probably. Sanders was talking about a $6 trillion budget and that's already dropped down to 3.5 trillion. A lot of speculation that it'll get smaller even before it passes the Senate or, or passes Congress. So I think that we're going to things could be smaller than initially anticipated. One thing important for real estate and tax is that the corporate tax provisions which were going to go in the infrastructure bill that was the Biden plan, are not going in the infrastructure bill. So all those corporate provisions are kind of moved forward into this partisan bill and that changes that may change some of the thinking on what the makeup on the individual and pass through and provisions important to real estate because you have a larger mix of potential tax changes to pay for that legislation.

So Ryan, that's helpful to know because my notes were before $6 trillion in the reconciliation package you said that looks like that's already come down to 3 and a when it was originally 6 trillion they were talking about that included a $2.4 trillion requirement for tax increases. So I would assume we've gone from six down to three and a half. I don't know if it's the same ratio and we'll see the need for tax increases come down. But if that's the case, the question is how do you solve for that? When you've got the Republicans saying we don't want any tax increases at all, you've got Manchin saying even for the corporate, which they're talking about, I think the Biden administration said they wanted to see increase from 21 to 28% mansions at 25% on that. And then I believe he's also said that he doesn't want to see a deficit spend. So maybe you could talk a little bit about what is the tax number we're solving for and kind of the push and pull between a hike, tax hikes to get us there versus deficit spending. I mean, do you see the latter in this case?

Yeah. No, I think it's a really important question. That last point that you raised, which is Senator Manchin has said it should all be paid for, which is very different from paying for 6 trillion bill with 2.4 trillion in taxes. I mean, there's a big gap there. So I don't think they've resolved that question or if they have, they haven't reported it yet. How much deficit spending are they willing to go along with? The 2017 bill was not paid for. That was all basically put on the credit card. There's an argument that some of this is an investment and therefore pays off in terms of productivity and growth. And so you can do some deficit spending, but you have members that clearly view that the whole thing should be paid for. I don't think they've reached, as far as I can tell, an agreement or consensus on that question. I still think, personally, I think deficit spending has to be part of this politically. And so we'll see. We'll see where they end up.

Perfect. I'm going to actually turn it over to Ken or Lisa if they have any questions for Ryan to help set the stage again before you go into your presentation. So did, did, did I miss anything? Is there anything else our listeners need to know right now about what's, what's going on down in Washington?

I think that the key to really for people understanding is we were trying to all understand the American jobs plan and the American family plan and who was paying for what and where it was going to go. I think Ryan, you know, illustrated and pointed out that who's paying for what at this point. I think they're looking at it from the totality and saying this is the total budget. Here are the things. I mean, that's a good thing, by the way, is that we're going to be able to say maybe some of these revenue raisers that they thought they were going to have, we might be able to make some modifications elsewhere. And Ken and I are going to get a little into it a little bit later on that step up in gains tax. There are alternatives to that. Right. And so hopefully we can have some conversations or we can get people to have conversations saying, you know, some of the proposals and remember, these are suggestions that were out there. Maybe we can have some conversations and say here's a different revenue raiser. Let's try to see if, you know, some of the studies are showing that some of these with 1031 isn't the great revenue Raiser that everyone thought it was, you know, that Ling and Petrova study that's out there and who's going to pay for that expense. And ultimately some of the families and individuals that they're trying to help could actually get hurt by some of these provisions. And I think that's really going to start coming to play as the conversations continue. Sorry, Ken, I didn't mean to jump in. Go ahead.

That's quite all right. I mean, and the implications of these, these provisions on the overall economy, as Lisa was talking about how it impacts the value of real estate, how it impacts the value of the stock market, what reactions you'll be seeing, I think that's also going to come into play in determining what actually happens. So hopefully Congress is looking at that as well and not just saying, okay, here's a dollar we need to raise and not looking what the consequences for that dollar raise are.

Yeah, Ken, you and I talked about. Sorry, Ken, you and I talked about what's going to happen to the triple net lease or the triple net lace market if some of this were enacted. You know, how are they going to value Those prop, those CVS's like Walgreens, you know, how would that happen if they get rid of 1031, take away.

1031 exchanges and you know, people are using, you know, basically triple net leases as the acquisition properties. Now the demand drops out. Are we going to see another, you know, savings and loan type crisis because banks have lent, you know, 85, 90% against these properties are now going to be 70 stuck with properties that are worth substantially less.

Ken, Lisa, you made some great points there on what to consider here and how this plays out. And I think, Ken, with what you just said about the potential impact and how the market is receiving it, I know BlackRock has been vocal about that JP Morgan and saying if these tax increases go into effect, I mean, you could see a major backlash in the market. So I'm sure, as you said, that the elected officials are considering that hopefully closely.

So.

Well, that was great to kind of set the stage. And for those in the audience, if you want to put your questions into the Q and A, we want this to be a conversation. We want this to be as helpful as possible. So I'm happy to bring questions to the floor as we go through this. But while we do that, Ken or Lisa, why don't we go ahead and dig into the deck that you've prepared so we can talk about some of these major proposals for our industry.

So we had a whole setup But I think that Ryan and James did a great setup of what this is and dividing as to who's supposed to be paying for what. And again these were the things, the highlights. This is the highlight reel that we're going to talk a little bit about as we walk through the presentation which is moving the top individual rate to 39.6%, changing that long term capital gain and that qualified dividend rate up to ordinary income rates if it's over a million dollars. And again that right now has that retroactive effective date which everyone's a little bit concerned about because that was back in April. We've never seen a retroactive date like that. The only time that there's generally a date where it is somewhat retroactive was when the bill is written and it might be passed later, but it might be as the date that the bill was written. It's rare that the retroactive date is as of when Biden made those suggestions in April. So I know that there's a lot of talk about that and there certainly is a lot of concern since a lot of transactions happen when people haven't had that right, you know, enough information to plan about that. We're going to talk a little bit about precaried interest rates, certainly get into a deeper dive on the like kind exchange deferral. And on the we'll talk about the permanent repeal of the excess business losses which will have some implications on some individuals that were able to get some ordinary losses on here. We're going to definitely talk about the step up in basis that we alluded to before and the implications that that could have. It's called the death tax, whatever you want to call it, the mark to market, all different things that are going on in the marketplace. But that's certainly going to have a lot of conversation around it. And then there's, we're going to talk about, you know, there are some green energy tax credits in there. We're not going to dive into too much on that because again the main areas are the capital gain rates changing and implications on that carried interest rates like kind exchanges and that death tax that we spoke about.

Perfect. So before we move on, question for Ryan. Just because the timing of this all is so critical and it's on everyone's mind I think back to the fourth quarter of 2012 and I don't know if you all remember what happened in the sales market but this was before they raised the capital gains from 15 to 23.8%. So that was back in my Massey NACL days when we were selling 300, 350 properties a year, we closed on 100 deals in the month of December. It was like Christmas every day for the brokers. I mean, we were signing contracts on December 26th and closing on the 31st. My sense is if this all happens January 1st, that we're going to see this mad rush for next year. So, Ryan, with what Lisa is saying, that if you look at history where retroactive treatment has never happened unless the bill has actually been written, I mean, if everything went according to plan, I mean, Ryan, when is the soonest that this bill could actually be written? And again, if you had to guess when this actually goes into effect, are we talking about a Jan 1, 2022 eventually?

Yeah, great question. I don't think we can say with certainty. That said, I know that members of Congress are hearing a lot of pushback on the administration's proposal to have the capital gains effective date be April 28th. They did not say that on April 28th when they released their proposal to raise capital gains taxes. People were not on notice for that. As you said, that's not how these provisions are typically enacted. If I had to guess, I would guess that we'll have an effective date that is around the time that the bill gets introduced or marked up, considered in committee. I don't think they will have a prospective effective date because then you have a big push to sell assets before that takes effect. So I think that you're looking. My guess would be in there's a range of possibilities here. But speaking just about the capital gains rate, I would expect the effective date to be for transactions after, say, the date of introduction of the bill is a very likely scenario.

But we're not giving any data.

Not to press you on that. But again, the range, again, because I understand they don't.

Yeah, April 28th. I don't think they go earlier than April 28th because that's what the administration said. I don't think they go back to January 1st of this year, for example. I just think there's problems with setting an effective date at January 1st of 2022 because you get the sell off of assets prior to that that generates revenue. So in one way that's positive, I guess, but I think that's a negative for markets. And traditionally the way capital gains changes are done, I think is typically the effective date is around the time that the bill surfaces. So I would expect introduction. I mean, I guess Your possibilities are April 28 to January 1, 2022. That seems to me Kind of the outer range.

If we were looking at that introduction date for the bill, when is that? That is scary. April, date of.

That's a good question too. I don't think it's this month. I think we're focused on the budget resolution. I don't think it's August because they'll have a recess and then they'll come back in the fall and I think that's when they will write the tax bill would be my guess. So sometime in September maybe, or even October possibly.

Perfect. Okay, Lisa, sorry to take you away from your slides, but I think the timing of this is just so critical and at the top of everyone's mind. So thank you, Ryan, for your, your guidance.

No, I was curious to see if he was going to give us a date. So thank you. So as we can see here, we're just talking about the increase in the top personal income tax rates going from that 37 to 39%, 39.6%. We're not going to spend two much time on this slide. You know, we were at 39%, 39.6% five years ago, six years ago. So this isn't something where, you know, this is novel to people. I don't think it's, you know, all that interesting or compelling. So, you know, this is what the proposal is and we'll see what gets enacted from that point of view. We can move to the next one. There's nothing too much there. Again, it's that capital gain rates that's really going to be the main driver here from that conversation as we just talked about here. And remember that that combination of the increase in capital gains rate and that elimination, what we're going to talk about in the 1031 exchange, it could actually result in less capital being made available for real estate. And we're going to go through some examples to show you how that could happen. So this could be an unintended consequence, right. Is to discourage long term investment because there's going to be no, there's no rate break now for holding anything long term versus short term. And so having something out there and that's really going to hurt when we're talking about forming value creation. Right. And really getting that product out there. And so again, I think we've talked about this a lot. The one thing in here also that needs to be added is that that 3.8% tax is also going to go on top of that capital gain investment and that three zero point net investment income tax. There was a provision that originally that Net investment income tax did not apply to a real estate professional. And so the proposal now is going to eliminate that example. So real estate investors are actually going to have to pay that net investment income tax of 3.8% on your rental income and the sales for properties. So that 39.6 that we saw in the earlier slide could now add 3.8% on top of it, which was not the case for a real estate professional with the prior law. So, you know, that's, that's just another 4% that's going to be added onto the capital gain for the sale properties and for your rental income, essentially. For real estate investors, we're going to keep giving good news.

I was just going to say if you and Ken flipped the coin to decide who was going to deliver this, although I don't know if. Ken, I know you've got some advice on strategies.

Got some bad news coming up.

We got to rip the band aid off, so thank you.

This is the slow tear and the next thing we've talked about, carried interest is nothing new to the news. When the TCGA came in and they took it away for private equity and for hedge funds, real estate was given that sort of exemption under 1231 gains, sale of real property held in the trader business. So, you know, real estate sort of got by where we can allocate some sort of a rate of return. And to the extent that there's a carried interest or promote that's going over to the general partner or the managing member right now, that allocation of income is taxed at capital gain as long as it's a 1231 gain or the gain from the sale of real property. The proposal out there right now is that that goes all to ordinary income rates with no capital gain. For this real estate community, there is something out there called the Carried Interest Fairness act, which has support on the floor by the Democrats. And that is already in there. So that's not even part of any of these plans that we talked about, this Carried Interest Fairness Act. So they've been wanting to get rid of this for a while. You know, again, it's that same unintended consequence. You know, perhaps there's going to be, right now you have to hold it for three years to get capital B treatment here. There's no holding, holding period anymore. Everything's just going to be at ordinary income rates and there's going to be no holding period for any of carried interest to get tax at capital gains, all of it. So private equity, hedge fund, real estate, private equity Any real estate transaction, it would all be at ordinary income rates regardless of the holding period. And again we've mentioned before, it really could deter from people making those long term capital commitments and investors or even aggregating capital and giving that promoter that incentive. So that really could change on how you structure deals, whether we structure them as debt going forward or other types of participation. But there's some unintended consequences here as well. In the carried interest I think that's.

Before is that it's too complicated because you do have debt layers which can participate potentially. So whether you structure something as debt or equity is going to depend on how you treat the developer and the manager who's basically creating the value here. If basically, if you're saying that all of his income is going to be ordinary, if he does debt financing, is it still ordinary? So you might be reducing the investment pool available for investors in real estate unless they're doing it through loans.

Right.

Which is going to limits their upside. And that's going to. It could really have adverse impact not only on the monies available for real estate investment, but also on the pool of investors who are available who can avail themselves of the potential growth in real estate.

Yeah, this is a major point on how these deals would be structured moving forward. And also Lisa, you mentioned the holding period and it might, you know, the treatment doesn't change for the longer term hold. You could see a lot of these funds making jumping in and out of investments. But at least as a practical matter, I mean for some of These longer most PE shops and most real estate investments are 5, 7 year holds. They're getting that preferred return. They've got that the developers getting the promote. So just so our audience understands how this works, I mean typically there's a capital event, whether it's three years, five years, it could be a refinance, it could be a sale. But if you have that promote on paper every year, they're not going to actually. Are they going to be going in every year and looking at that promote or is it only when there's actually that capital event that this tax is going to be due?

There's a proposal as part of the proposals is like a mark to market every 20 years for partnerships, s corporations and trusts. So even if you've earned the promote and you haven't paid it out, they can mark you to market and hit you with the ordinary income at that point.

Yeah, that's unfortunately what I remember hearing or reading. So it would seem probably most groups will not be holding for 20 years then. But yeah, who knows?

There's no incentive. Very long term hold, there's no incentive. And even for the short, why hold something for a year if you can flip it for a small profit right away? Ordinary income rates versus capital gain rates, it's going to change the way people do business. Makes sense. And you know, it also gives the extent you're taxing capital gains at ordinary income rates. Why sell a piece of property if you can finance it out and take out equity going forward? Very good point. You do that, right? Are you going to put money into a property that you've already done the work on? You basically bought a piece of property, you added the value and you finance it out and you sit pretty for a long time. You're not going to re add value to that for a long period of time. And maybe the 20th year, if you're going to pay tax anyway, you sell it at that point. So it's going to change the way people think about real estate holding and hold property for a very long time. You tend not to improve it after a certain period of time. And that's bad for the local economy. It's bad for the economy in general. We're going to talk about that in 1031 exchanges.

And I think we're on to that.

Ken, we're onto the 1031 exchange. So there was a study done by Ling and Petrova that basically looked at the economic activity of 1031 exchanges. So it is a job generator. 568,000 jobs in the the 1031 market. Labor income was 27.5 billion. Value add to the real estate was 55.3 billion. And federal and state and local revenue was 7.8 billion from 1031 exchanges. It's used in approximately 10 to 20% of commercial real estate transactions. There's a lot of restrictions in how to do 1031 exchanges. So that basically it does require people to dot their I's, cross their T's and fit within the regulations. But they're still very common and there's an industry around it. When people sell property that they've held for a very long time and they don't want to pay tax currently because under the current rules, if somebody is 70 years old and they've been operating a property for 25 years, it's time for them to not operate a property anymore and to basically sit back and clip coupons so they can sell their real estate and buy triple net lease type property as 1031 replacement property and clip coupons with a property that they've held for this very long time, they probably haven't improved it in a very long time. The person who buys that property is going to basically put money into it, improve it, add value, increase the local economy from that, and really make a, an improvement to the overall economy from buying the property that was available for 1031, the relinquished property, as they call it. If you're taxing the gain at ordinary income rates, and you're not, and we'll get to the other piece on Step up, you're not getting a step up at death. It's going to be a real disincentive to do a 1031 exchange even if your gain is only $500,000, because you're not going to get the step up at death. So you're converting the gain that you would recognize as capital gain into ordinary income through rent collections because you don't get the depreciation on the new property that you're buying. It really takes the whole incentive out of the 1031 market. You don't get the step up, why bother doing it?

And Ken, to add, right, the study showed that the new when you do enter into a 1031 exchange, 30% of those deals typically have 30% lower leverage, right, which strengthens that marketplace to begin with. So people are actually exiting out of the buildings that have a higher leverage into a lower levered building. And so that certainly strengthens that sector.

And this example that I'm going to go through kind of illustrates how much money goes back into the local, you know, into the economy from doing a 1031 exchange. So today, if you have a building that you purchased for a million dollars, you've taken depreciation for 10 years, your tax basis is down to about 740,000. You can sell it now for $2 million. You had a debt on it of a million two, which means you refinanced at some point. But you would have net cash proceeds of $800,000. If you do a 1031 exchange, you're going to buy a replacement property for $2 million and you'll have 800,000 of equity in the new piece of property. Pretty straightforward. The government gets zero. You have a real investment in property for $800,000 and it might be a triple net lease property that you don't have to run. But it's in the economy, it's invested in real estate. If you limit it to 500,000, you're going to basically have to pay tax on the gain on the gain in excess of $500,000, which in this case is 756,000. You have capital gain on the true economic gain less than 500,000 of 20%, which cost 100,000. You have the net investment income tax, and you have depreciation recapture at 25% on the 256,000 of depreciation you claimed. So your total Federal tax is 192,000. If you're in California, your tax rates are pretty high. You have 100,000 estate tax. And California does accept the 1031 exchange, but it would be on, you know, limited to the 500,000 gain exclusion. So your total taxes are about 293,000, and your remaining equity to invest in the economy is 506,000. That all goes into piece of property, presumably, except for the monies you use to pay tax. If you eliminate 1031 exchanges completely and just basically sell your property, and capital gain rates remain the same, you have about $300,000 remaining equity after you pay your tax on the full gain. So the 1031 is the difference between $800,000 invested versus $300,000 available to invest. And if they change the capital gain rates to ordinary income and you don't have 1031 exchange available, you left with $87,000. So I'm asking you as an audience, if you could sell your piece of property for $2 million, which is a nice profit over something you bought for $1 million. And yes, you financed out and you probably took four years, four or five hundred thousand. When you finance out. If you can sell it now and walk away with $87,000, wouldn't you just hold it and collect rent or refinance it? You know, maybe you can refinance it for a million five. You know, you get more money on a refinance than you would on a sale. It doesn't make any sense to sell property. Not selling the property creates a disincentive for people to put money into property and improve it, hurting the local economy, reducing the number of jobs. So overall, I think it's a bad economic analysis to not have 1031 exchanges or to limit them to 500,000. And yes, more than half of the 1031 exchanges are between 5 and $600,000. I think it's even higher than that.

And don't forget, property makes up a 1031 exchange. It's generally a multifamily property. Right? And so this is what we need for housing. So these are, these are the types of properties that end up in a 1031 is multifamily. That's the capital that we need to create that workforce. And affordable housing is in this type of asset in this sector.

Right.

And not having 1031 available basically will have existing stock of multifamily housing deteriorate versus being improved by a new buyer.

Yeah. To me, the choice is so clear when you look at the numbers in your last slide with the job creation and the economic activity. And just to be clear, that $7.8 billion of tax revenue we were talking about per year, is that correct? That's what the 1031 generates. My notes on this proposal to eliminate 1031s over $500,000 would only create $19.5 billion of revenue, tax revenue over 10 years. So, you know, again, you know, if you're looking at the numbers here, you know, exceed that in a little over two years, it would be very short sighted for all the reasons that you gave before. So Ryan, again, the big question everyone is asking is, does this happen? What is the Real Estate Roundtable? What's your opinion on this? What do you think the likelihood that this happens? Is it an all or nothing? I mean, could there be a scenario where 1031s can continue as they have under $500,000, but maybe there's another tranche between 505 million and maybe half of that exchange could happen in 5 million plus you're out of luck. I mean, what's the likelihood that this happens in its current shape?

Yeah, James, look, there's a lot of issues, as we know we're going through them now, that hit real estate that have been proposed. I don't think anyone is higher on our agenda than section 1031. I refer to it as it's the kind of the grease that makes commercial real estate finance work. And we hear about it constantly from in from the industry about how important this is to really making commercial real estate, helping businesses grow, etc. I'm cautiously optimistic. I think we've made tremendous progress. There are members of Congress who have direct engagement and have done like kind exchanges and are very familiar with them and understand how they're used. There are a lot more members of Congress that have no idea about them and just assume it's some tax shelter out there. So, you know, we spent a lot of time kind of raising awareness about it. You know, I think the number one, you heard a great presentation on this just now and we could talk about the arguments for it for the next hour. And I know we don't have time to do that. But I think the biggest thing in my mind is to get away from this idea that this is some kind of tax break for investors. It is really a tax provision to facilitate the growth of businesses that are actually active in operating and managing real estate. And that's really who's using this. And you only get it if your business is expanding or not shrinking at a minimum. And that's what we see in the marketplace. It gets properties into the hands of new owners, properties that might have been languishing into the hands of new owners that have the time, resources, interest in improving them. It's really good for liquidity of real estate markets. Really important post pandemic with so much real estate being repurposed for other uses, that's going to require new ownership in a lot of cases. So I think we are, this is one where people should not hesitate to reach out to their contacts in government. Elected officials make sure they understand how important this issue is. But this is not just a real estate. We pull together. The farming, agriculture, forestry, ranching, even land conservation industries are all part of this effort to really raise awareness on this issue. I, you know, 500,000 is not work that is not a viable. In fact, you know, in terms of the jobs impact, that's not helpful at all. The jobs really come from the larger commercial real estate properties that employ a lot of contractors, a lot of people to manage the all aspects of owning the business. You know, the 500,000, maybe it's useful for a small mom and pop with a vacation home or investment property or something, but doesn't really do much at all for commercial, real, commercial real estate. So I feel good, but it's not close. The risk is still there and people should not hesitate to reach out to their contacts on this issue.

Thank you for sharing that. And just anecdotally, we have a contract out right now for the development deal in New York for over $50 million. And there is a provision in the contract where if the 1031 is eliminated while in contract, the deal is null and void. So that's how powerful this is because the owner has basically said, hey, if there's no 1031, I'm not selling. And again, this is a development deal. So if there's no development, there's no construction jobs, the new retail tax base that it'll bring to the area. So it's just that, that's one example. But when we looked back over the last three years, half of our transactions involved the 1031 on one side of the equation or the other. And sometimes someone who you know that example I just gave where a seller will only sell if they can exchange, or a buyer who's only looking to trade up if they can have that advantage. So, and I know for my friends who do triple net, they tell me that 70% of the buyers have 1031. So if this goes away again, you're going to see a huge drop in sales activity. So to our audience, thank you so much for joining us. I'm sorry we didn't get a chance to go through the questions. As you could tell, there's just so much subject matter here. We did cover a lot. One of the questions we did get is whether or not the deck will be available. I mean, we're going to post this on my YouTube channel so you can actually watch this again. We'll also rerun it on my podcast if you want to listen to it. Maybe it motivates you to do something. Certainly if it's a real estate transaction, you might be thinking about doing that sooner than later. But Ken, Lisa and Ryan, I just want to thank you all for sharing this information and especially Ryan for all the great work that you're doing down in Washington. You're really the voice and hopefully really sharing some common sense being because the real estate industry is such an important driver for the economy and we want to make sure that it keeps moving. So thank you again to all and we look forward to being in touch.

A Different approach to Putting our Clients first Avis and Young's Tri State Investment Sales Group sells multifamily office, retail development and specialty sales throughout the New York metro area. As experienced thought leaders in our industry, our 35 member group is available to help you make informed investment decisions by advising you on your current holdings or identifying new opportunities in the marketplace. Our one unified team is built on an industry unique platform which promotes unparalleled collaboration and teamwork. We share core values of hard work, integrity and expertise. We put our clients first, providing tailor made strategies to achieve superior results. Please Visit us at aytristateinvestmentsales.com and follow us on Twitter LinkedIn and Instagram amesnelsonnyc to learn more. Thank you for tuning in this week to Real Estate Investing Live from New York. Please join your host James Nelson for another program next Tuesday at 7pm in New York, 4pm Pacific Time on the Voice America Business Channel. All shows are rebroadcast on Wednesday mornings at 7am Eastern Time and 4am Pacific Time as well as always on demand. We'll talk again next week.