Kansas lawmakers gave corporations tax breaks for 1031 exchange properties

When Kansas politicians approved a compromise tax cut bill last month, the deal included a little-known policy change that gives certain corporations tax breaks.

The 1031 exchange rule is a complex piece of tax policy that has received little attention, despite being controversial when it was not included in a larger tax package.

Supporters say the change is intended to benefit certain commercial real estate investors and tenants who claim their properties are paying artificially high property taxes. Opponents, however, argue that the change places a greater property tax burden on individual taxpayers.

What did lawmakers say on this issue during the special session?

The 1031 exchange language was part of Senate Bill 1, the special session compromise tax plan negotiated by House Speaker Dan Hawkins (R-Wichita), Senate President Ty Masterson (R-Andover) and Democratic Gov. Laura Kelly.

The provision was debated in the Senate, but after less than an hour, further debate on the entire package was halted.

Senator Marci Francisco (D-Lawrence) brought up the topic.

“My concern would be that there’s clearly been a lot of attention and discussion about the various tax proposals in the bill, but there hasn’t really been an opportunity for a lot of people to voice their opinions on this part or have a hearing,” Francisco said of the 1031 exchange. “I know our Douglas County assessor had some concerns about this language.”

Sen. Caryn Tyson, R-Parker, responded that the 1031 exchange language had previously been passed by the Senate in Senate Bill 311 and in House Bill 2096.

“We debated it, we voted on it, we passed it,” Tyson said. “It’s very frustrating to suggest that this is not transparent.”

“I didn’t say we haven’t discussed this issue before,” Francisco said, “but I was just surprised to see it in the tax bill, and I think there was no opportunity for individuals to raise it as part of this bill. … This bill is important, and I don’t think it should be used as an opportunity to insert something that I don’t think is specifically related to our taxes.”

This provision was not debated in the House of Representatives during the special session.

The only mention of 1031 exchanges came when the clerk read the bill’s title and when Rep. Adam Smith, R-Weskan, gave an overview of the bill. He told colleagues only that the provision was also in an earlier volume dealing with whether 1031 exchanges should be included in property appraisals and that “we have rules and regulations that say they can’t be included, but this puts it in the statute.”

The House Tax Committee has never held a hearing on a standalone bill addressing 1031 exchanges, but the Senate Tax Committee did so in 2023 and 2024 with Senate Bill 311. The Senate later narrowly passed the bill by a vote of 21-19.

What is a 1031 exchange?

Sellers of commercial or investment properties generally must pay taxes on any gains at the time of sale, according to the Internal Revenue Service. But like-kind exchange transactions under Section 1031 of the federal Internal Revenue Code allow sellers to defer paying taxes on those gains if they reinvest the proceeds to purchase a like-kind property.

They are also known as a Starker exchange.

Mark Burghart, secretary of the Kansas Department of Revenue, told senators that the 1031 exchange applies to investment properties.

The new law in SB 1 means that the sales price or value for a 1031 exchange cannot be taken into account for real estate valuation purposes. Specifically, they are prohibited from being considered an indicator of fair market value or used in determining fair market value for real estate tax purposes, and they are excluded from valid sales for purposes of the sales ratio study used to measure the accuracy of tax valuations.

Why is this important?

The only proponent to testify on the issue was Eric Estes, who appeared before the Senate Tax Committee in March 2023 to support Senate Bill 311. Estes is a multi-business retailer. He explained the issue using examples of existing shopping centers and newly built restaurants and coffee shops.

“Oftentimes, after the developer is done, they will market these properties,” he said. “They don’t just market the property … they actually market it as an intrinsic value.”

In addition to the real estate, Estes said the long-term guaranteed lease and its associated income stream is “what the buyer buys and what the seller sells.” Triple-net leases are especially valuable because the tenant pays all the costs, including taxes, insurance and maintenance.

“What we’re seeing now is everybody jumping out of the stock market, as we’re seeing today, real estate is a great move, 1031 exchanges have been around for a long time,” Estes said. “It’s a tax diversion tool that’s been very successful, and it’s been very successful for a lot of people.”

“It works for both the buyer and the seller,” Estes said. “The only people it doesn’t work for are the people on the land who are the tenants.”

The problem, Estes said, is that if appraisers use the sales price of a 1031 exchange when assessing the value of the property, it can inflate the value, leading to an increase in property taxes. If there is a triple-net lease, then the tenants are responsible for the tax increase.

He said that in one such case, when a shopping center was sold, his Qdoba’s tax bill skyrocketed, as did bills for a balloon store and a flower shop, both of which could not be paid.

“So when I say taxes can bankrupt someone, I really mean it,” Estes said. “It really happened, and it happened in real time last year.”

It could also affect other commercial property owners and tenants, even if they weren’t involved in the 1031 exchange. That’s because the value of a 1031 exchange was used as a comparable sale when appraising other properties in the area, increasing their taxes, despite what Estes said is “just not a fair assessment.”

He said the legislation “only alerts appraisers and valuers that this was a 1031 exchange, not the actual value.”

Estes said the changes to 1031 exchanges “help both small and large businesses.”

Are Homeowners Losing Money?

Sen. Tom Holland, D-Baldwin City, said at the March 2023 hearing, “I see it as being most beneficial to those mall owners and large developers who are preparing to sell something … a way to reduce their property taxes prior to a 1031 sale.”

He said it is also beneficial for the buyer of the property, as it reduces the tax burden.

“I am concerned that the owners of large developers, developers of shopping centers, are going to be able to significantly reduce their property taxes as they prepare for a 1031 exchange sale, and that the property taxes are going to be shifted directly to the homeowners,” Holland said. “I think this is very dangerous legislation. I will vote against it and ask the committee to consider the implications of this.”

Dark shopping theory

At one point in the legislative process, the 1031 exchange proposal was coupled with another tax policy known as the dark store theory.

That issue stems from a property tax dispute with major retail chains. The Kansas Supreme Court in 2022 rejected arguments that stores were overvalued because. While some county appraisers valued buildings while taking lease values into account, retailers argued that their stores should be valued as if they were vacant.

Holland warned in 2023 that he believed the original version of SB 311 had implications for the dark storage theory.

“I don’t think we understand half of the implications of this bill. … This, to me, is the dark store theory being implemented without the dark store being accepted,” he said.

The Senate Tax Committee passed the original version of SB 311 in 2023, but did not move forward. When the committee considered the bill again in 2024, it amended the bill to also cover build-to-suit and sale-leaseback agreement transactions.

Sen. Ethan Corson, D-Fairway, said during the floor debate on SB 311, “We’ve never had a hearing on these two pieces.”

He described it as “artificially devaluing the value of these comparable commercial properties,” thereby circumventing the Kansas Supreme Court ruling.

“If we artificially empty these commercial properties, who’s going to make up the difference?” Corson said. “It’s going to be, once again, on the backs of you and my residential property owners.”

“I would argue that we’re charging too much for these properties,” Tyson said. “They’re paying more than they should be paying, and so this bill would address that problem.”

The provisions regarding build-to-suit and sale-leaseback transactions were not part of the 1031 exchange provisions included in the special session bill.

When an earlier tax package was debated late into the night on the final day of the legislative session, Smith was the only House lawmaker to mention the provision. He said it was the dark store theory component that was causing concern. He also acknowledged that the House Tax Committee “hadn’t had a chance to actually have a hearing” and didn’t “fully understand” it.

How should real estate be valued?

When the Senate debated the bill in March, Sen. Usha Reddi, D-Manhattan, expressed concerns, saying, “It goes back to the residents, and they’re going to have to foot the bill.”

Reddi suggested that the bill, which at the time contained provisions for dark stores, would mean vacant properties could become less valuable than they should be.

“I’m going to oppose this because I’m not sure we’re addressing fair market value and market value in the right way,” she said. “And it’s going to impact our communities in a worse way than we anticipate.”

Francisco, who said she personally participated in a 1031 exchange, questioned why the sales price should not be considered fair market value.

“Why wouldn’t you consider the price of the property you buy as a fair market price?” said Francisco.

“It’s the property that needs to be valued, not its potential revenue,” Tyson responded.

“I think you’re saying that you’re prohibiting the sales price that a property is sold for as fair market value,” Francisco said. “But how else do you set a price for that sale and for the future property taxes that are going to be paid on that property?”

“It shouldn’t be included in the value of the property,” Tyson said. “They can calculate the value of the property based on the market value of other comparable properties.”

Jason Alatidd is a Statehouse reporter for The Topeka Capital-Journal. He can be reached by email at [email protected]. Follow him on X @Jason_Alatidd.