Buyers can use 1031 exchanges to help their neighbors
The National Multifamily Housing Council reports that, in the U.S., undersupply of housing has led to a decline of 4.7 million affordable apartments between 2015-20201. The competition for that attainable rental housing has increased the share of cost-burdened American households paying more than 30 percent of their income for housing to nearly 37 percent in 20212. As an option for residential investment property owners at all economic levels, the benefits of 1031 exchanges extend beyond tax deferral and wealth creation for landlords to a natural incentive to preserve, develop, and build quality and attainable housing for the community good.
Liquidity in the rental housing market can positively affect the quality of housing and the ability to transfer ownership for a property’s best use. If a landlord cannot keep up with the maintenance on a property and wants to exit from the investment, a sale is inevitable, or the property owner chooses to move into another investment to upgrade or diversify, Section 1031 provides an incentive to sell because of the tax deferral and the ability to shift the owners’ investments. This vulnerable property then becomes available to other new buyers, who are more likely to improve or renovate a property with greater investment, creating better quality housing for renters. And, these improvements benefit adjacent property and the surrounding community.
Communities with small and larger development face the same issues. Fluctuations in rents and serial turnover in ownership can lead to displacement of neighborhood residents, especially important in both low-income neighborhoods and in high-demand communities. Studies on the impact of 10313 have shown that exchanges stabilize rents. Because an exchanged property must be held for investment—not as a flip—there is an incentive for an owner exchanging in to hold the property.
Small, individual investors, “Mom & Pop” landlords, make up a large majority of existing affordable housing options—duplexes, small apartment buildings, and accessory units, such as an apartment over the garage, a basement apartment, or a stand-alone house in the backyard. These landlords are often members of the community in which they own investment property.
Larger, institutional investors and mission-driven organizations can also take advantage of Section 1031 exchanges to provide affordable housing. Large, underutilized commercial and retail spaces are being redeveloped into mixed-use and residential buildings—converting offices, shopping malls, big box stores, retail space, and even parking lots into housing. Development proposals for conversions of office space-to-residential have included requirements for affordable housing as part of redevelopments in cities like Chicago and Los Angeles. The extra capital from the tax deferral can become the deciding factor that makes a conversion project feasible. Again, for existing apartment buildings, that tax deferral can become funding for renovations, improving the quality of life for those who rent and live in the apartments.
With 40 percent of 1031 exchanges being multifamily housing4, exchangers are able to help neighbors who face housing insecurity. Property owners must sell to use Section 1031, and improved properties increase rent potential for investors, so other tax tools are primary solutions for owners who retain property, but 1031 exchanges fill in gaps not covered by other incentives. Small and large investors are empowered by Section 1031 to preserve, improve, and develop attainable rental units that positively impact their communities while benefiting from the proceeds of their investments.
1National Multifamily Housing Council. The Housing Affordability Challenge. July 27,2022. https://www.nmhc.org/advocacy/issue-fact-sheet/housing-affordability-fact-sheet/
2National Multifamily Housing Council, National Apartment Association, and Sharon Wilson Geno. Tax Policy’s Role in Increasing Affordable Housing Supply for Working Families. March 7, 2023. https://www.nmhc.org/globalassets/advocacy/testimonies/2023-03-07-sharon-wilson-geno-senate-finance-committee-testimony-on-behalf-of-nmhc-and-naa.pdf
3Federation of Exchange Accommodators. Section 1031 Economic Studies. April 24, 2023. https://1031buildsamerica.org/section-1031-economic-studies/
4Federation of Exchange Accommodators. Letter to members of the U.S. Senate Finance Committee. March 16, 2021. https://fea1031buildsa.wpengine.com/wp-content/uploads/3-16-21-Coalition-Congressional-ltr-like-kind-exchanges-03.16.2021.pdf