Avoiding Taxes at Any Cost: The Economics of Tax-Deferred Real Estate Exchanges
- 283 Downloads
This study examines the role tax-deferred exchanges play in the determination of reservation and transaction prices in U.S. commercial real estate markets. Taxpayers face significant time constraints when seeking to complete a delayed tax-deferred exchange. In a perfectly competitive market, a weakened bargaining position would not affect the transaction price. However, in illiquid, highly segmented commercial real estate markets, the exchanger may be required to pay a premium for the acquired property relative to its fair market value. Using a unique and rich dataset of commercial property transactions, we find that tax-motivated exchange buyers pay significantly more, on average, than non-exchange investors for their apartment and office properties, all else equal. Moreover, these average price premiums generally exceed the tax deferral benefits investors obtain by the use of a tax-deferred exchange. This result is robust to a number of alternative specifications. Thus, for many investors the pursuit of tax avoidance comes at a steep price.
KeywordsCommercial real estate Tax-deferred exchanges Transaction price
- Davidson, R., & MacKinnon, J. G. (1993). Estimation and inference in econometrics. New York: Oxford University Press.Google Scholar
- Fickes, M. (2003). 1031 Exchanges do more than save taxes. National Real Estate Investor, January, 59–62.Google Scholar
- Forgey, F. A., Rutherford, R. C., & VanBuskirk, M. L. (1994). Effects of foreclosure status on residential selling price. Journal of Real Estate Research, 9(3), 313–318.Google Scholar
- Griliches, Z. (Ed.) (1971). Price indexes and quality change. Cambridge, MA: Harvard University Press.Google Scholar
- Halvorsen, R., & Palmquist, R. (1980). The interpretation of dummy variables in semilogarithmic equations. American Economics Review, 70(3), 474–475.Google Scholar
- Hardin, W. G., III, & Wolverton, M. L. (1996). The relationship between foreclosure status and apartment price. Journal of Real Estate Research, 12(1), 101–109.Google Scholar
- Hardin, W. G., III, & Wolverton, M. L. (1999). Equity REIT property acquisitions: Do apartments REITs pay a premium? Journal of Real Estate Research, 17, 113–126.Google Scholar
- Internal Revenue Code, Title 26, Section 1001(c) (2006). Available via http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00001001----000-.html. Cited 26 June.
- Internal Revenue Code, Title 26, Section 1031 (2006) Available via http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00001031----000-.html. Cited 26 June 2006.
- McBurney, C. M. (2004). Section 1031 exchanges: A legitimate tax shelter for business. Thompson FindLaw, May.Google Scholar
- McBurney, C. M., & Boshkov, S. (2003). Is an attribute of an intangible in a 1031 exchange a separate asset or inherent in an existing asset. Journal of Taxation, 98(1), 46–53.Google Scholar
- McLinden, S. (2004). 1031 Exchanges test the waters. National Real Estate Investor, June, 45–47.Google Scholar
- Shilling, J., Benjamin, J., & Sirmans, C. F. (1990). Estimating net realizable value for distressed real estate. Journal of Real Estate Research, 5(1), 129–140.Google Scholar
- Starker vs. United States, 602 F. 2d 1341 (9th cir., 1979).Google Scholar
- Wayner, S. A. (2005a). 1031 exchanges defer tax bills and boost broker commissions. Real Estate Finance, February, 31–32.Google Scholar
- Wayner, S. A. (2005b). Section 1031 exchanges: Underused tax-planning tool. CPA Journal, June, 16–17.Google Scholar
- Weirick, W., & Ingram, F. (1990). Functional form choice in applied real estate analysis. Appraisal Journal, January, 57–73.Google Scholar
- Weller, L. S., & Halfacre, D. A. (2004). Section 1031 market continues to grow. Deloitte Tax LLP.Google Scholar