Election may hold key to real estate exchange

A couple of years ago, Kandas Myer recalls, it wasn't uncommon for her to face another frenetically busy day at the office with the thought, "This has got to stop."

Myer, the regional manager in Reno for Starker Services Inc., and other folks who deal in 1031 real estate exchanges have seen the business slow dramatically as the real estate market cools.

Some wonder, however, if this November's election and the possibility that a Democratic win would boost the tax rate on capital gains might kick it into a higher gear.

The 1031 exchange industry, which gets its name from a section of the federal tax code, was established to help real estate investors defer some taxes.

Essentially, sellers of property can follow a strict set of rules to reinvest the proceeds of a sale of one investment property into another piece of real estate without facing a tax bill right away. Specialized companies known as "qualified intermediaries" handle the transactions.

Qualified intermediaries boomed as investors in residential real estate looked to defer taxes during the boom in the middle years of this decade. That changed.

"There are fewer investors entering the market to drive sales and exchanges," says Craig Chagnon, division manager in Reno for Asset Preservation Inc., a qualified intermediary firm.

And he notes that investors also are taking dollars out of real estate for alternative investments, thinking they can make a better return without the headaches that come with owning property.

Some exchange firms, Chagnon says, have seen their transaction volumes fall by half during the downturn.

But the slower activity also may mean fewer dumb deals are getting done, says Myer. Under the rules of 1031 exchanges, sellers need to identify a new property to acquire within 45 days and close the purchase within 180 days.

When deals were flying fast and inventories were low, Myer says some buyers were panicked into making offers that didn't make financial sense.

Now they're under less pressure.

"If you can get your property sold, there are lots of opportunities in today's market," says Chagnon.

Some commercial real estate brokers think the 1031-exchange business may be set for an uptick.

Tom Johnson, who owns the Sperry Van Ness offices in Reno and Carson City, says exchanges historically have accounted for anywhere from to 10 to 20 percent of his company's transactions.

Property owners who think that a win by the Democrats in November would bring a rise in the capital gains tax from the current 15 percent are likely to give a fresh look at tax-deferred exchanges, Johnson says.

"Everyone is betting that the capital gains rate is going to go to at least 25 percent," he says. "I'm anticipating that we are going to see more exchanges."

On the other hand, changes in the capital gains rate might reduce the number of transactions, says Todd Blonsley of the commercial real estate brokerage Marcus & Millichap in Reno.

His reasoning: Some investors who have been letting their profits ride from one exchange to another may decide to get out of the game while tax rates are still low.

But Blonsley doubts the business will dry up entirely.

"There always will be 1031 business," he says. "There always will be people who are going to be averse to paying taxes."

He notes, too, that pending legislation from Nebraska Congressman Adrian Smith would provide more time to get 1031 exchanges done. The bill would give investors 90 days to identify a new property and 360 days to close the purchase.

Chagnon, meanwhile, thinks the qualified intermediary business may get some additional impetus from the growth of so-called "tenant-in-common" programs that allow smaller investors to join forces to buy institutional-grade commercial real estate.

As those programs attract new real estate investors, some of them will look at exchange programs to defer some taxable gains.