CHAPTER 5
 SIMULATING THE MAGNITUDE OF PRICE EFFECTS FOR EXCHANGES

 As previously discussed, taxpayers face significant compliance risk when seeking

to complete a tax-deferred exchange. Moreover, the exchanging taxpayer may have

compromised his or her bargaining position with potential sellers of replacement

properties. As a result, the taxpayer may be forced to pay a premium for the replacement

property, assuming the marginal (price determining) buyers and sellers in the market are

not motivated by Section 1031 tax deferral benefits and compliance issues. In a

competitive market, the magnitude of the price discounts accepted by sellers of

relinquished properties and the price premiums paid by acquirers of replacement

properties should not exceed the incremental NPV of the exchange strategy, with the

actual magnitude of the premium depending on market liquidity, the negotiating abilities

of the taxpayer and other potential buyers and sellers, and whether or not potential buyers

and sellers are aware the taxpayer is attempting to complete a Section 1031 exchange.

 Before turning to the empirical estimates of the price discounts offered by sellers

of relinquished properties and the price premiums paid by purchasers of replacement

properties, equation (16) is used to simulate the magnitude of INCNPVt under a number

of plausible assumptions. Simulated values of INCNPV, are then divided by the price of

the replacement property at time t to determine the percentage price effect. These

simulations are intended to quantify the maximum percentage price effects that are likely

to be found in the subsequent empirical work.