THE MANIFESTATIONS OF 1031 EXCHANGE

In the City…

In 2005, Donald Trump’s partners in a real estate development deal sought to sell the asset for $1.8 billion. Trump resisted the deal even though his cut was $500million. It was only when the partners agreed to effect a 1031 transfer of the capital gains from the sale-to purchase two office towers and not owe any tax on those gains.

Today, Trump’s stake in the buildings is worth north of $1.2 billion before accounting for debt.

The so-called 1031 like-kind exchange rule, named after a section of the tax code, was created a century ago to aid family farmers. It has evolved into a beloved tool of property moguls, Fortune 500 companies and real estate trusts that can use it to create a daisy-chain of tax avoidance.

It works like this: An investor buys a building for $4 million and sells it later for $10 million. By redeploying the proceeds into a new property within six months, she can defer paying taxes on her gains. She can repeat that process indefinitely.

When coupled with another tax break that wipes out all capital gains at death, the 1031 provision can enable real estate investors to forgo capital gains taxes entirely, enabling family dynasties to pass on riches to heirs virtually tax-free. Some wealth managers call the strategy “swap ’til you drop.”

Trump and partners also purchased 555 California St. in
San Francisco as part of their 1031 exchange

The National Association of Realtors argues that 1031 exchanges are crucial to keeping the commercial real estate market humming and that they’re primarily used not by the super-rich, but by less affluent retirees, investors and landlords.

Yet Internal Revenue Service data shows that more than one-third of the tax savings from 1031s goes to large institutional investors such as real estate investment trusts and corporations. The tax break is also used by the richest Americans, from the Trump and Kushner families on the East Coast, to billionaires scooping up hundreds of thousands of acres of ranch land in the American West.

Facilitation abounds…

A cottage industry of lawyers, brokers and intermediaries has developed to allow smaller investors to reap tax savings from 1031 transactions. Tens of thousands of small investors each year put their capital gains in pooled investment vehicles, called Delaware Statutory Trusts, to purchase properties and develop real estate. A study funded by the real estate industry and based on voluntary data from buyers and sellers estimates that the average purchase price of properties bought using 1031 exchanges is $500,000 and that 88% of all exchanges ultimately lead to a taxable sale.

“Section 1031 encourages real estate transactional activity, and in doing so, is a powerful stimulator of the U.S. economy,” said Suzanne Goldstein Baker, co-chair of the government affairs committee at the Federation of Exchange Accommodators, which lobbies to preserve the policy.

While some publicly traded companies disclose their 1031 activity in broad terms in SEC filings and investor calls, most private companies that use the rule make few details public. In Trump’s case, specifics came to light during a legal battle in which he accused his partners of selling the properties for less than they were worth. Eric Trump and Trump Organization General Counsel Alan Garten didn’t respond to questions seeking comment on the company’s use of the rule.

The family of Trump’s son-in-law, Jared Kushner, also benefited from a 1031 transaction that will take the sting out of their plan to sell a building for less than they paid for it. In 2007, as the U.S. property market was reaching an apex, Kushner Cos. sold more than 16,000 apartments for $1.9 billion. That included about $1 billion of capital gain, Charles Kushner, Jared Kushner’s father, said in an email to Bloomberg News. “As it is common practice in the real estate industry, we looked to take advantage of the 1031-exchange provision of the tax code,” the elder Kushner wrote.

Kushner Cos. purchased 225 W. Randolph St. in Chicago more than 13 years ago in a 1031

exchange that enabled it to defer capital gains taxes.

The family then purchased a Chicago office tower for $275 million, allowing for the deferral of that much of the capital gain. Thirteen years later, the company had an agreement to sell that Chicago property for about $180 million...

It’s never a good deal to sell properties for less than their purchase price, but in this case, the 1031 rule will allow Kushner Cos. to continue to defer capital gains from the 2007 sale equal to the value of the Chicago building’s eventual sale price.

“We intend to use the same 1031-exchange provision of the tax code to defer” taxes on that amount as well, Charles Kushner wrote, adding that the $28 million in cash that his company will take out of the building is greater than the $17 million it put in.

In the Country too…

Now, Sam Middleton, a real estate broker whose family has specialized in selling Texas land for more than a century, says losing 1031 exchanges would be a crippling blow to the market for family estates and family farms. He says about half of his firm’s deals involve 1031 exchanges.

“It’ll kill my business,” Middleton said. “For the large ranches, and for the smaller properties, too, the $5- to $10 million ranches for people who just want a place to get away for the weekend. It’s a very important part of the finances.”

His Chas. S. Middleton and Son firm is currently handling deals involving some of the state’s most storied properties: the Matador Ranch, operated by a subsidiary of Koch Industries Inc.; and the 6666 Ranch, which is being purchased by a group of investors including Taylor Sheridan, the actor and director who created the TV show “Yellowstone.” Middleton said he did not know whether either group planned to use a 1031 exchange. Spokespeople for Koch Industries and Sheridan didn’t respond to requests for comment.

Middleton is also brokering the sale of part of the 260,000-acre La Escalera ranch south of Fort Stockton, Texas. San Antonio construction magnate Gerald Lyda benefited from a 1031 exchange when he bought the property in 1992 using his capital gains from selling a New Mexico ranch to cable television billionaire Ted Turner. In an interview archived at the University of Texas at San Antonio, Lyda said the transaction’s details were too complex for him, so he “spent over a hundred thousand dollars getting it done right through professionals.”

Lyda died in 2005; his widow and other family members have run La Escalera as a hunting ground, farm and Black Angus cattle ranch, while earning additional income leasing the property’s energy and mineral rights.

Now they’re among the largest land owners in the U.S., according to the Land Report, and they’re selling 35,000 acres at an asking price of $41 million to billionaire real estate mogul Stan Kroenke, Middleton said. Kroenke, who married into the Walton family of Walmart Inc. fame, owns hundreds of retail shopping outlets, as well as the Los Angeles Rams, the Colorado Avalanche NHL franchise, the Denver Nuggets NBA team and Britain’s Arsenal F.C. soccer team. A spokesman for Kroenke declined to comment for this story.

“Real estate industry analysts say that 1031 exchanges involving ultra-wealthy purchasers tell only part of the story. Family farmers and ranchers routinely use exchanges to upgrade and sometimes reorganize their properties”, said Roger McEowen, who teaches agricultural law and taxation at Washburn University School of Law in Topeka, Kansas.