A 85-year-old tax law has gone a long way in the past few years toward attracting and retaining an influx of new capital to Tulsa and the state, professionals involved in like-kind exchanges of property said.
Section 1031 of the Internal Revenue Service code, enacted in 1921, allows capital gains taxes to be deferred when an investment property is exchanged or sale proceeds are rolled over into a similar investment.
“We’ve see it more and more recently, just from a standpoint of taxpayers wanting to defer payment of taxes,” said accountant John F. Grace, CPA/ABV, of Stanfield & O’Dell, 3211 S. Lakewood Ave. “The biggest thing to realize with the 1031 exchange is that it is not a tax escape. You are not escaping from a taxation, you are deferring it.”
Although local property owners are increasingly using the 1031 exchange to protect the gains they may have realized in their property holdings, investors from hot property sections of the country, particularly from the coasts, are using the tax law to invest large amounts in Tulsa-area properties.
“You see some of both,” Grace said. “It seems like there has been a lot of talk about people coming into and acquiring property in Oklahoma, and they may be using the 1031 deferrals. But it also helps a lot of people here when they have had properties for a length time and they find out that if they sell they give a big chunk of what they thought was their nest egg in the form of taxes.”
If you sell a property that has appreciated significantly in value, “you have to pay a huge amount of capital gains tax,” he said. “Even though the rate could be as low as 15 percent, it is still taxable.”
“When you have people in California wanting to get out of that market for whatever reason – maybe they’ve made a bundle because of the enormous appreciation of properties there – and they want to find markets that are suitable places to plant their money, they will use 1031 exchange money to move that money from a California property into properties in Oklahoma,” said Richard W. Riddle, attorney and qualified 1031 intermediary with Riddle & Wimbish.
Riddle is also president and general counsel of Oklahoma Title & Escrow Corp., 5314 S. Yale, Ste. 200.
“I would venture to say that almost every large real estate deal that we have seen in the last 2-3 years has used 1031 exchange money,” he said.
Keeping Capital Local
Chuck Patterson, chairman and CEO of Patterson Realtors, 2642 E. 21st St., Suite 170, agreed that there has been a large increase in the use of 1031 exchanges over the past 2-3 years.
“I know a lot of it came from out of state, as savvy investors in overheating markets have a tendency to look to other areas,” he said.
Just the ability to have a 1031 exchange results in more available capital in the market, Patterson said.
“A person did not have to pay taxes on it, so they had more capital available to them. But in order not to pay taxes, they must reinvest it,” he said.
“The impact is that it has indeed facilitated the influx of capital into the state,” Riddle said.
“Capital stays here instead of going to Washington. In fact, instead of going to Oklahoma City,” he said. “It has been a boon for getting capital in, and it has been a boon for keeping capital here.”
It’s 1031: Do You Know
Where Your Tax Dollars Are?
Although professionals could not provide specific figures on how 1031 exchanges have grown, they said that increasing knowledge of the advantages of utilizing the 1031 deferral has boosted its use among local investors.
“There is no question that there is a level of use and familiarity on both coasts that we have not had before,” Riddle said. “Now the real estate community is gathering steam, and in the last five years it’s really on the front of their minds.”
“Today the odds are – at least in the metro areas and among the real estate brokers involved – that if somebody is getting ready to do a real estate transaction … they will suggest a 1031 exchange.”
“More people are hearing about 1031 because they see articles – or advisors, such as CPAs, are making their clients aware,” Grace said. “It is really incumbent on the business advisor to let taxpayers know how to save taxes and improve their cash flow.”
As a result, there are more 1031 exchanges in terms of both number and size, Riddle said.
“Of course we have been very active since 2002-2003 with the turn in the economy,” he said, adding that his firm handles transactions as small as a $60,000 rent house or as large as a $30-35 million deal.
As an intermediary, gets intervenes when cash is involved and more than two parties are part of the 1031 exchange.
“The way Congress originally envisioned this was that it was a swap statute,” he said. “Two people got together and they decided they wanted each other’s property. Congress’ concept was that they are really staying invested in the same property – it’s just a different form of property because it’s a like-kind – so they would not charge a tax.
“Now, there are usually four parties involved in the whole process,” Riddle said. “We have the taxpayer who wants to sell his property, we have a buyer who wants to buy his property, we have a seller who wants to sell the taxpayer his replacement property and we have a qualified intermediary who facilitates the deal.”
“The intermediary has to step into the shoes of the taxpayer for purposes of receiving the cash proceeds of the sale,” Riddle said. “And the Intermediary has to be engaged before you close the sale of the transaction.”
For a typical 1031 exchange, an investor has 45 days after selling a property to identify a replacement property and 180 days to close the transaction, Grace said.
Tulsa Market Heating Up
Patterson said there are many reasons why outside investors are interested in using 1031 exchanges to invest in the Tulsa market.
“The values of property here are very low,” he said. “Our ad valorem tax base is very low. Our rents aren’t very high either. But investors could go in expecting the prospect of gain on their properties.”
“At the same time we have been coming out of the ‘01-02 and early ‘03 job losses which further depressed our market,” he said.
He said investors began to move into Tulsa “particularly in 2005 when our chamber (Tulsa Metropolitan Chamber of Commerce) won the national best chamber award, when we began with our meager job gains – those same gains became significant when compared to other places – and again, just the plain overheating of the market.”
He said there were other factors that garnered the attention of investors.
“There was a stable economy that already went through a downturn and we had Vision 2025 pass, which changed the image, future and psychology of our community. Earlier this year, we had a city government change – certainly the mayor (Kathy Taylor) change, with a different style of leadership,” he said.
Riddle sees the potential for increased interest in Tulsa.
“I think Tulsa is becoming a hot property,” he said. “The folks in Tulsa County have taken the initiative to invest in their future through Vision 2025 and other measures where they have chosen to tax themselves in order to promote the city.”
Investors saw that, he said. “They saw what’s going on downtown, the possibilities of the inner core development and the progressive nature of the mayor and now the city council.”
“They are willing to put their money where their mouths are,” he said, “and there’s just tons of it.” ?