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Tuesday, November 09, 2004
Tax Shelters Cause Concern
If you were a landlord of commercial property and a buyer offered a price greater than the market value of your property, would you be elated?
Who wouldn't? But part of you also might be worried.
A tax shelter trend is gaining ground around the United States. It's called "1031 exchange buyers."
The buyers purchase commercial real estate as a group of tenant-in-common investors. As this article in Crain's Cleveland (subscription required) points out, these investment groups consist of investors who:
"[band together] with other investors to buy other properties in order to shelter their proceeds from capital gains taxes. The exchanges take their name from the section of the federal tax code that allows them."
Because they are sheltering tax gains, these investors are tempted to overpay compared to other buyers who do not have capital gains to shelter.
The danger is this can inflate the real estate market.
Short term I don't suppose we will hear many sellers complaining.
However, real estate investors and successful small business owners with capital gains they'd like to shelter might want to remember history.
Back in the late 1980's I worked in banking. It was quite common to see small business people with real estate investment portfolios that made no sense except for tax shelters.
Then the U.S. tax laws changed. The shelters were eliminated. Those real estate portfolios went up in smoke faster than a crack head's stash.
Suddenly an inflated real estate market became a deflated market -- in a matter of months. The only thing that grew was the bank's real estate owned (REO) portfolio following foreclosure.
As one commercial landlord in the article above says: "he considers the tenant-in-common buyers 'a disaster waiting to happen,' and likens the phenomenon to the real estate syndications of the 1980s that were driven by tax-shelter considerations. Those deals went bad after Congress in 1986 reduced tax benefits for real estate."
For buyers and sellers of commercial real estate, this is a troubling trend.