How Kansas politicians gave a controversial property tax break to businesses

When Kansas politicians passed a compromise tax cut plan last month, the deal included a little-known policy change that gives a tax break to certain businesses.

The 1031 exchange provision is a complex piece of tax policy that received little attention, despite being controversial when it wasn't bundled into a bigger tax package.

Supports say it is intended to benefit certain investors and tenants in commercial real estate who contend their properties are paying an artificially high property tax, but opponents argue that the change shifts more property tax burden onto residential taxpayers.

What did legislators say about the issue during 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 got some discussion in the Senate before the chamber cut off further debate on the entire package after less than an hour.

Sen. Marci Francisco, D-Lawrence, raised the topic.

"My concern would be that, clearly, there's been a lot of notice and discussion about the various tax proposals in the bill, but there really hasn't been an opportunity for many people to weigh in on this part or have a hearing," Francisco said of the 1031 exchange. "I know that our Douglas County appraiser had some concerns about this language."

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

"We've debated it, we've voted on it, we've passed it," Tyson said. "To imply that this is not transparent is very frustrating."

"I did not say that we haven't debated this topic before," Francisco said, "simply that I was surprised to see it in the tax bill, and I think that there wasn't an opportunity for individuals to address it as part of this bill. ... This bill is important, and I don't think should be used as an opportunity to insert something that I don't feel particularly relates to our taxes."

The provision received no debate in the House during the special session.

The only mentions of 1031 exchanges were when the clerk read the title of the bill and when Rep. Adam Smith, R-Weskan, gave an overview of the bill. He told colleagues only that the provision was also in a previous bundle, dealt with whether 1031 exchanges should be considered in property appraisals and that "we have it in rules and regs that those are not to be included, but this does codify it in statute."

The House tax committee never had a hearing on a standalone bill on 1031 exchanges, but the Senate tax committee did in 2023 and 2024 with Senate Bill 311. The Senate later barely passed the bill in a 21-19 vote.

What is a 1031 exchange?

Sellers of business or investment property are generally required to pay taxes on any gains at the time of the sale, according to the Internal Revenue Service. But like-kind exchanges under section 1031 of federal internal revenue code allow sellers to postpone paying tax on that gain if they reinvest the proceeds to buy a similar property.

They are also known as a Starker exchange.

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

The new law in SB 1 means the sales price or value for a 1031 exchange cannot be considered for property valuation purposes. Specifically, they are prohibited from being considered an indicator of fair market value or used in arriving at fair market value for property tax purposes, and they are excluded from being considered valid sales for purposes of the sales ratio study used for measuring tax appraisal accuracy.

Why does it matter?

The only proponent to testify on the issue was Eric Estes, who went before the Senate tax committee in March 2023 to support Senate Bill 311. Estes is a retailer with several businesses. He explained the issue by using examples of existing strip malls and newly built restaurants and coffee shops.

"Oftentimes, after the developer is done, they will market these properties," he said. "They market them not just by the real estate ... they're actually marketing this as an intrinsic value."

In addition to the real estate, Estes said the long-term guaranteed lease and its income stream is "what the buyer is buying and what the seller is selling is." Triple-net leases are especially valuable because the tenant pays all expenses, including taxes, insurance and maintenance.

"What we're seeing now is with everyone jumping out of the stock market that we see today, real estate's a great move, 1031 exchanges have been around a long time," Estes said. "It's a tax diversion tool that's very successful, and it's very successful for a lot of folks."

"It works for both the buyer and the seller," Estes said. "The only folks it doesn't work for is the folks on the ground that are the tenant."

The problem, Estes said, is that if appraisers use the sale 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 on the hook for the tax increase.

He said in one such instance where a strip mall was sold, his Qdoba's tax bill spiked, as did the bills for a balloon shop and a flower shop. Those two businesses couldn't pay.

"So when I say taxes can put somebody out of business, I truly truly mean that," Estes said. "It really has happened, and it happened in real time last year."

It can also affect other commercial property owners and tenants, even if they weren't the ones involved in the 1031 exchange. That's because the value of a 1031 exchange has been used as a comparable sale when appraising other properties in the area, thus raising their taxes, despite Estes saying, "That's just not a fair assessment."

He said the legislation "just alerts the appraisers and assessors on the ground that this was a 1031 exchange, it's not the real valuation."

Estes said the changes to 1031 exchanges "helps both small businesses and large businesses."

Do residential property owners lose?

Sen. Tom Holland, D-Baldwin City, said in the March 2023 hearing, "I see it as basically being most beneficial to those strip mall, big box developer owners that are getting ready to sell something ... a way to basically lower their property tax burden prior to the sale of a 1031."

He said it also benefits the buyer of that property by lowering their tax burden.

"I'm concerned about basically owners of basically big box developers, developers of strip malls, being able to significantly reduce their property tax burden as they prepare for a 1031 exchange sale, and that property tax burn is going to get directly shifted over to residential homeowners," Holland said. "I think this is very dangerous legislation. I'll be voting no and ask the committee to consider the ramifications of this."

Dark store theory

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

That issue stems from a property tax dispute involving big box retailers. The Kansas Supreme Court in 2022 rejected arguments that stores were being overvalued because. While some county appraisers were valuing buildings while considering the lease's value, retailers argued that their stores should be valued as if they were empty.

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

"I don't think we understand half of the consequences of this bill. ... This, to me, is 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 it didn't advance after that. When the committee took the bill up again in 2024, it amended the bill to also cover build-to-suit and sale-leaseback arrangement transactions.

Sen. Ethan Corson, D-Fairway, said during floor debate on SB 311, "We never had a hearing on these two pieces."

He described it as "artificially deflating the value of these comparable commercial properties," working around the Kansas Supreme Court decision.

"If we artificially deflate these commercial properties, who's going to make up that difference?" Corson said. "It's going to be, again, on the backs of your and my residential property owners."

"I would argue that we're overcharging on these properties," Tyson said. "They are paying higher than what they should be, and so this bill would address that issue."

The build-to-suit and sale-leaseback arrangement transactions provisions were not part of the 1031 exchange language that made it into the special session bill.

When a previous tax package was debated late into the night of the last day of the legislative session, Smith was the only legislator in the House to mention the provision. He said it was the dark store theory part that caused concern. He also acknowledged that the House tax committee "hadn't had a chance to really have a hearing" and didn't "fully understand" it.

How should property be valued?

When the Senate debated the bill on the floor this March, Sen. Usha Reddi, D-Manhattan, raised concerns and said, "It's going to go back to the residents, and they're going to have to pick up that tab."

Reddi suggested the bill, which at that point had the dark store provisions, would mean vacant properties could be valued less than they should be.

"I will be opposing this because I'm not sure we are really addressing the fair market value and market value as it should be," she said, "and it's going to impact our communities in a worse way than we are foreseeing."

Francisco, who said she has personally participated in a 1031 exchange, questioned why the sales price shouldn't be considered for fair market value.

"Why would you not use that price of the property you're purchasing as a fair market price?" Francisco said.

"It's the property that should be valued, not the potential income for the property," Tyson responded.

"I think what you're saying is you're prohibiting the sale price at which a property sells as being used as a fair market value," Francisco said. "But then how else do you establish a price for that sale and for the future property tax that should be paid on that property?"

"It should not be included in the value of the property," Tyson said. "They can figure the value of the properties from fair market value of other similar properties."

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

This article originally appeared on Topeka Capital-Journal: How Kansas politicians gave a controversial property tax break to businesses