1031 Exchange Not "typically Motivated"

[Phil McDonald]

While reading an article discussing the allocation of value among different components the author proposed that a sale involving a 1031 exchange does not meet the definition of market value since the purchaser is not “typically motivated”. I disagree, what do others think?

The author makes the case that since tax considerations are a factor the buyer is not acting prudently. My position is that of course the buyer is acting prudently and tax considerations are an underlying consideration in every commercial real estate transaction.

A buyer involved in an exchange has 180 days to purchase a replacement property which in my experience is sufficient time. While working as a commercial broker many clients were involved in 1031 exchanges and while some ran up against a deadline most were closing on transactions with plenty of time remaining in that window and many would look to identify properties prior to closing on the original transaction. I never encountered a buyer who was not acting prudently and purchasing a property above market just to complete a 1031 exchange.

What do others think about a 1031 exchange not being a transaction involving a “typically motivated” buyer.

 

[Randolph Kinney]

Market value is determined or identifying the most probable buyer group.

Since single family residential homes are not considered as investments by most buyers ( typical buyers are not motivated by the income or tax advantage) but are motivated by the private enjoyment of owning and living in the home.

 

[Gobears81]

Market value is determined or identifying the most probable buyer group.

That is actually a key here. A huge portion of 1031 money is going towards national NNN properties, which is one of the many factors that has resulted in values for that type of property being somewhat inflated. For that type of property I would not discount the sale as not being market oriented, simply due to being purchased by a 1031 buyer, given that 1031 buyers ARE the market in many cases. I have also written up sales in the past, and it was concluded that a premium was paid, due to being purchased by a 1031 buyer. You could make a case where 1031 buyers are not typically motivated, due to having to purchase a property in a certain time frame. I agree that 180-days is ample time in some cases, but that is based on the assumption that they are looking from the first day. Investors that are not tied to 1031 rules can look for properties in three months, but if they don't see anything they like at that point, they can wait a couple months or a couple years. Or maybe they don't actively look to purchase a property unless the opportunity presents itself. There is no constraint. Hence, for many markets, 1031 buyers would not be typically motivated.

 

[Howard Klahr]

Some do, some don't. It can depend on many factors. There is not an automatic adjustment but rather the affect on the transaction is identified thru the conformation process. Also a 1031 may involve more than one property on either side of the transaction as well as depending on the type of 1031 utilized.

 

[Deleted member 128537]

This is an interesting question. I work in a second home market and 1031's are not uncommon to avoid capital gains. I just don't use 1031 sales as comps just because they are quirky. But from a second home market situation this would be an interesting discussion. I really haven't thought it through. Anyone have any literature on this?

 

[glenn walker]

I live in Los Angeles County California and this issue is very dependent on area and prices. We have homes that were purchased 25-45 years ago that have gone from $60,000 to over $1,000,000 and in these cases often owners want to sell and move that equity into another property and they do an exchange which is just a paper move. Many of these are single family homes that have been rented for many years ! And in 99% of the cases the sale's data or MLS does' not even mentions an exchange because in reality it's just a sale and a paper move to defer capital gains.

 

[Deleted member 128537]

Do

I live in Los Angeles County California and this issue is very dependent on area and prices. We have homes that were purchased 25-45 years ago that have gone from $60,000 to over $1,000,000 and in these cases often owners want to sell and move that equity into another property and they do an exchange which is just a paper move. Many of these are single family homes that have been rented for many years ! And in 99% of the cases the sale's data or MLS does' not even mentions an exchange because in reality it's just a sale and a paper move to defer capital gains.

Do you treat them as typical sales then? 1031's are disclosed in our MLS.

 

[Phil McDonald]

Thanks for your replies and insight. Good point on the impact to the NNN lease market. A change in the tax code regarding 1031 exchanges would create a market adjustment. Similar to what happened to all commercial property when the tax code changed regarding depreciation. Tax implications are always a factor in commercial real estate investment.

I agree that uncovering buyer motivation is essential in the confirmation process. I guess this is more on point to my question. I am curious how frequently appraisers are obtaining information on confirmation that a buyer in a 1031 exchange did not act prudently because of the 1031 exchange. I have rarely encountered anybody telling me this and when it happens it is subtle. I have never had a buyer tell me they paid way too much for a property because they were in an exchange or a listing agent tell me they had this overpriced listing and were so happy when the non-typically motivated 1031 exchange buyer came along so they could sell it above market. It just does not happen like that.

In my encounters, experienced commercial real estate investors are generally well informed investors. Granted we all recall the few who have not been but the majority are.

I just have not experienced this when dealing with buyers as a commercial broker or when verify 1031 sales with brokers and participants. I am curious how often others encounter something different when verifying sales.

 

[Michael S]

I've confirmed probably 100+ NNN single tenant sales and at least half involved 1031 exchanges. I'd say maybe 5-10% of those had atypical motivation where a broker indicated that the buyer overpaid as they were getting close to the deadline on their exchange. In all cases the difference was 5% or less.

 

[Terrel L. Shields]

While reading an article discussing the allocation of value among different components the author proposed that a sale involving a 1031 exchange does not meet the definition of market value since the purchaser is not “typically motivated”. I disagree, what do others think?

Most farm transactions here involve 1031 if the seller is going to have major capital gains. Only rarely do they pay extra and only when acceptable purchases are scarce.