Since 1921, Section 1031 of the I.R.S. Tax code has encouraged capital reinvestment for individual property owners, small businesses, large corporations and investment fund managers, like The Hampshire Companies, LLC (“Hampshire”). The 1031 Exchanges Code permits the deferral of capital gains tax on the sale of property held for investment or productive use in a trade or business.
For more than 60 years, Hampshire has used these types of exchanges to swap properties since they offer us a reliable wealth creation tool. These types of investments are carefully sourced and researched to ensure they will be suitable for the selling entity’s investment criteria. Throughout our history, we have executed hundreds of these deals leveraging the benefits for a variety of our investment funds.
For example, we could use a tax-deferred exchange to dispose of an investment property and utilize the proceeds from that sale to purchase a value-add property in another market. Deferring the capital gains tax allows us to utilize the totality of the proceeds from a sale to maximize our purchasing power for the next investment. A 2014 study by David Ling and Milena Petrova dated March 2015 found that investors typically acquire more valuable replacement properties (in excess of $305,000 than the property sold) when participating in a 1031 exchange. These exchanges provide liquidity and are immensely valuable to firms such as ours because they allow for the sale of both under-performing assets and performing assets without significant immediate tax consequences. 1031 exchanges are a powerful wealth creation tool, and we have utilized them to maximize the value of our funds and ensure stable returns for our investors.
We are also able to leverage our relationships with developers and other property owners to source and purchase properties, eliminating outside costs to gain the maximum benefits of the exchanges. This allows us to maintain a large inventory of properties available for possible sale, providing us with greater flexibility in negotiating deals than smaller firms. Our unique experience in executing these types of deals positions us well to reduce risk and provide stable returns while maximizing the additional investment dollars gained by utilizing 1031 exchanges.
Lately, 1031 exchanges have been in the headlines and have been a frequent target of those seeking to reform the tax code to eliminate loopholes and create a simpler tax structure in the United States. Critics argue that these exchanges are effectively tax-free and exist as another loophole in an overly complex tax code. However, it is very important to note, these exchanges are simply tax-deferred, not tax-free. Most exchanges result in an eventual capital gains tax payment. For many property owners, the elimination of this program would cause a significant impact in their business model and significantly decrease transaction activity. This would very quickly slam the brakes on commercial real estate investment and would also result in ancillary professions tied to 1031 exchanges, including lawyers, accountants, contractors and brokers, suddenly seeing their businesses take a steep turn. As 1031 exchanges are currently estimated to account for over $8 billion of the United States’ GDP per Ernst and Young Macroeconomic Study Overview dated March 2015, the impact of any elimination to this program would have a devastating ripple effect on the economy and potentially freeze up capital markets throughout the country. Characterizing these exchanges as a tax loophole shortchanges the vital role they play in commercial real estate and our economy.
At Hampshire, we leverage our more than 60 years of cycle-tested experience to offer a diversified investment platform. 1031 exchanges are only one of the platform and investment strategies Hampshire uses to manage its private funds. Check back for updates on this topic as we’ll be watching it closely.