Hoop Dreams: Impact of arena questioned


     When a basketball arena moves into the neighborhood, what happens?

     Chris Hansen’s proposed home for an NBA franchise (and maybe a hockey team, too) is still in the arguing phase, but already there is considerable speculation and concern about the impact of the arena’s construction, according to a recent research report issued by the real estate services firm Kidder Mathews.

     It’s not just the arena, for which Hansen has already spent nearly $54 million in assembling properties, the report notes. It’s also the push for more hotel rooms, more apartments, more nonindustrial uses in what is one of Seattle’s last large concentrations of manufacturing and warehouse operations.

     Those trends are meeting with resistance. The Port of Seattle and the longshore union are already on record opposing the arena’s siting just south of the Safeco Field parking garage. (Kidder Mathews says there’s a large market for leasing yard areas near the port.) Industrial firms in SoDo were unhappy with the encroachment of retailing, residential, entertainment and related activities well before the arena proposal surfaced. And as the Kidder Mathews report notes, the city has maximum size restrictions on nonindustrial uses in a designated area of SoDo (the arena itself is proposed for an area where such activity is allowed).

     What Kidder Mathews is predicting, and what the port and some industrial tenants of the area fear, is a tight local real estate market getting even tighter—and more expensive. Kidder Mathews says the 3.44 percent vacancy rate easily bests other markets in the Puget Sound region. By comparison, South King County, the state’s largest industrial market, had a 6.5 percent vacancy rate in the fourth quarter of 2012.

      The long-term impact, according to Kidder Mathews, will be “a loss of industrial supply.” That echoes an assertion made in a Seattle Planning Commission report last summer: “The proposed arena is likely to put further conversion pressure on nearby manufacturing and industrial business.”


The Tax-Deferred Exchange

The Tax-Deferred Exchange

Is the end of Section 1031 on the horizon?

While most people outside the public accounting field are not able to recite tax code sections, those who work in the real estate industry are likely familiar with Section 1031.

As a refresher, Section 1031 of the Internal Revenue Code allows property owners to defer gain from the sale of property when they exchange it for like-kind property. Under this code, the gain is not recognized until the replacement property is sold. If the replacement property is exchanged for other like-kind property, however, the property owner can continue to defer the gain recognition.

A Brief History
The concept of trading land goes back hundreds of years to when property owners bartered with one another. Tax-deferred exchanges were officially included in the Revenue Act of 1921, which allowed two parties to simultaneously exchange property without recognizing gain. In 1979, the Starker decision expanded the rules to accommodate exchanges, known as forward exchanges, that did not close on the same day. In 1984, an amendment to the Internal Revenue Code imposed the 45- and 180-calendar-day limits. Under this amendment, owners were required to identify a potential replacement property by the 45th calendar day, post closing, and complete the exchange within the 180th calendar day, post closing. 

When Section 1031 was enacted, it had three purposes. First, it prevented unfair taxation of ongoing property investments. When property owners reinvested sale proceeds and retired debt into new property, they did not have the cash to pay taxes resulting from the gain. Thus, forcing the taxpayer to pay the tax would have been unfair. Second, Congress wanted to encourage active reinvestment; the deferral of gain through reinvestment encourages taxpayers to replace and upgrade their property. The third purpose was for administrative convenience, which ceased to be relevant years ago, as deferred exchanges have becoming increasingly complex.

The Issue
Recently, the Obama Administration’s 2017 fiscal year budget proposed a $1 million limit per taxpayer on the annual deferral of capital gain. In addition, the budget renders art and collectibles ineligible for gain deferral. 

The U.S. Department of Treasury notes that Section 1031 deferral had historically been justified on the basis that valuing exchanged property is difficult, which is no longer a valid argument. Most exchanges are complex three-party exchanges, facilitated by a qualified intermediary.

These types of exchanges were not contemplated when the provision was enacted. In addition, the U.S. Department of Treasury believes that the ability to exchange unimproved real estate for improved real estate encourages “permanent deferral” by allowing taxpayers to continue the cycle of tax-deferred exchanges.

This is not the first time that changes to Section 1031 have been proposed. Tax-deferred exchanges have been part of tax reform proposals in both the Senate and House of Representatives for several years.

Proponents of Section 1031 note that a repeal of tax-deferred exchanges will cause a decline in real estate values, as it discourages investors from selling and reinvesting in other property. Instead, investors will invest in more liquid, non-real estate investments with faster returns. Further, proponents argue that owners who have acquired property through like-kind exchanges do not have cash to pay the tax. As a result, it would be unfair for property owners to pay tax on the gain when they did not receive cash during the transfer. 

With the upcoming change in administration, no one knows what the future holds for Section 1031. For the time being, tax-deferred exchanges are an excellent tool for real estate investors. They allow owners to defer payment of capital gains tax when selling property and reinvest the proceeds in like-kind property. However, the rules can be complex. Managing them correctly is vital to taking advantage of this longtime tax code benefit. If you are considering entering into a tax-deferred exchange, make sure to consult your tax adviser