Having spent most of my career working to support and improve the economic well-being of Ohio, I know that our tax code is too complex, contains too many loopholes and serves as a barrier to job growth.
In my three terms in Congress, I have advocated for a simpler code, with lower rates for everyone and incentives for small businesses to expand and hire new workers.
Since 1921, U.S. tax law has held that exchanging one property for a similar property should not be taxed.
Here’s how it works, and why it’s so important: Normally, when you sell a property, you have to pay taxes on any capital gains that you’ve earned. This can lead investors to hold onto their properties indefinitely, discouraging them from expanding their holdings or creating any new jobs. However, under Section 1031, if you roll over your capital gains into a similar investment – let’s say you trade one piece of real estate for a larger one – you can defer taxes on your capital gains.
Having worked to promote economic development and job creation in the private sector, I know firsthand the incentive this provides to encourage businesses – particularly small businesses - to reinvest in their businesses and grow. In my home state of Ohio, for example, property owners participated in nearly 20,000 like-kind exchanges between 1997 and 2014. These exchanges are allowing many Ohioans to expand and grow their businesses, creating more jobs and economic activity in our state.
This longstanding, commonsense tax incentive encourages investors to seek out new opportunities without going deep into debt. In Ohio, the initial mortgage on a like-kind exchange property averages 51 percent of the property price, compared to 58 percent for all other property acquisitions. In essence, these exchanges put more money in people’s pockets, and actually generate new tax revenues for our local, state and federal governments.
That’s why Ohioans and all Americans should be concerned that, in his last two federal budgets, President Obama has proposed taxing like-kind exchanges, as have members of Congress from both parties.
Before considering this tax hike, I encourage all policymakers to study a 2015 report by finance professors Dr. David Ling of the University of Florida’s Warrington College of Business and Dr. Milena Petrova of Syracuse University’s Whitman School of Management. After examining 1.6 million transactions over 18 years, they concluded that repealing the current policy would wreak economic havoc.
For typical property owners who want to roll-over their gains on commercial properties, a repeal of this provision would raise the effective tax rate on their investments to 30 percent. That means that in order for these commercial properties to generate the same rate of return, these investors would have to pay 7.7 percent less in acquiring them, thereby driving down property values.
Meanwhile, in order for residential rental properties to generate the same rate of return for investors, the acquisition price would have to decline by 10.6 percent, or rental income would have to increase 11.8 percent.
If investors could no longer plow back their capital gains into new properties, they would have to borrow more money, adding to the growing debt burden on the economy. Moreover, with less money available for improvements and expansions, investors would create fewer jobs. That’s the last outcome we need during a shallow recovery after a deep recession.
Less job creation, fewer business expansions and lower property values all add up to a consequence that those in favor of taxing like-kind exchanges don’t want: Reduced revenues for the federal, state and local governments. In an example of “the law of unintended consequences,” such a move would not only throw the engine of our economy -- the private sector -- into reverse gear, but would also do little to relieve the fiscal problems of the public sector.
Tax reformers from both parties want to reduce rates while closing loopholes and broadening the base. But repealing like-kind exchanges is the wrong way to try to do the right thing.
Stivers has represented Ohio’s 15th Congressional District since 2011. He sits on the Financial Services and the Rules committees.