In twist, 1031 exchange rules may be weakening NYC investment sales

IRS tax regulations allow owners angry with city’s new regulations to sell and move equity to “red” states tax free

By Adam Pincus

One of the bankable catalysts for the New York City commercial property market has been the IRS’s 1031 exchange regulations, which encourage real estate reinvestment by deferring capital gains taxes.

The problem today is that there are owners who perceive the city as being stubbornly anti-landlord, and the 1031 exchange law facilitates the sale of a property. That alone would not be a problem. The issue for the city’s investment market is that 1031 sellers, with cash in hand, are often moving their proceeds outside the five boroughs, dinging the collective demand to buy here.

“People in New York City are redeploying outside of New York,” Eric Anton, a broker with Marcus & Millichap, said. He said the impact of 1031 by itself was marginal, but when combined with the new rent regulations and other factors acting as headwinds, becomes part of a meaningful shift driving down sales in the city. Some sellers are only looking to buy in “red” states after selling in New York, one broker said.

The code may also be having another unintended impact that is cutting into sales. The tight window within which a seller must repurpose the funds requires a buyer to reinvest quickly. But the New York City market is still digesting the controversial package of rent-regulation laws that steeply cut values of stabilized rental buildings. In addition, state and city legislators are considering new legislation that real estate investors see as anti-business, such as a retail vacancy tax.

“Although [refinancings] are hot right now, that war chest of money is patient and very selective. No urgency due to a tax hit like in 1031,” said Marco Lala, a broker with RM Friedland.

That lack of urgency, unlike with a 1031, allows an owner who has cashed out through a refinancing to set the money aside and possibly reinvest in New York without the pressure to make a move immediately.

On a more mechanical level, the problem in the current declining market is that with fewer sales, there’s less 1031 money to reinvest, further depressing demand. That’s the inverse of a rising market, when the increased sales velocity and higher pricing is cycling money back into a market already in high demand, thus increasing upward pricing pressures.

“I felt a spike in the activity because there was still 1031 money lying around,” said Amit Doshi, a broker with Meridian Capital Group. “But that will disappear in the first or the second quarter [of 2020] because there is not going to be enough trades to exchange into and out of.”

Some, such as Lala, said the 1031 reserve was nearly spent already.

“There is little to no 1031 money left. Nada,” Lala said in a text.