‘Tis the season for political mudslinging. While we try to stay above the fray, one policy point did catch our attention: is Joe Biden planning to do away with the 1031 exchange?
We’ve heard this claim before. As recently as 2017, House Republicans had the 1031 exchange in the crosshairs of tax reform legislation. In fact, “real property” is the last man standing among a slew of exchangeable goods that have been cut from Section 1031. Livestock, construction equipment, copyrights and even airplanes could be exchanged under old tax code.
In a 1031 exchange, real estate investors can defer capital gains taxes by rolling the proceeds of a sale into a like-kind property.
While the Biden tax plan doesn’t directly say Section 1031 is on the chopping block, Bloomberg quoted a senior campaign official noting that like-kind exchanges would be included in the proposed tax plan.
What’s At Stake?
The Joint Committee on Taxation projects that investors would save $51 billion from 2019 – 2023 with 1031 exchanges. With Biden’s tax plan ringing in at an estimated $775 billion over 10 years, revenue from 1031 exchanges is just a portion of the tax breaks on the line.
In a recent campaign speech, Biden said “The way we pay for it [tax plan] is by rolling back…unproductive tax cuts for high-income real estate investors.” Like most of the Biden tax plan, we can assume that these tax changes will impact those with an annual income over $400,000.
Why Cut the 1031 Exchange?
Some pundits see the presumed attack on like-kind exchanges as a jab at the sitting president, who has benefited from real estate tax breaks. Ending these exchanges would, in theory, pump billions of dollars in capital gains tax from real estate transactions into what Biden calls the “caring economy.”
The mechanics of Biden’s tax plan indicate that ending real estate tax breaks like the 1031 will fund critical shortages in elder care and child care. And while the outcomes of Biden’s plan are intended to support low- and middle-class families hurting in the wake of COVID-19’s extraordinary economic devastation, industry experts point out some flaws in the plan.
National Association of Realtors VP Shannon McGahn noted that only 5% of exchanged properties are performed by corporations – most exchanges benefit sole proprietors, partnerships, and S corps. In turn, those exchanges are likely to inject money back into local economies via a local investor and through the professional services facilitating the transaction.
McGahn and others point to a struggling business landscape and wonder if now is the time to further depress commercial real estate transactions. Empty or half-capacity retail, restaurants and offices are scraping by as it is. Yanking the option to deploy Section 1031 could push these assets into further stagnation.
“Like-kind exchanges are particularly important during economic downturns when access to capital is less certain,” says Jeffrey DeBoer, Head of the Real Estate Roundtable.
While the sky isn’t falling (yet), some investors are seeking to move funds to Opportunity Zone projects. An Obama-era program, Opportunity Zones have bipartisan support in D.C. and appear to be a safer bet during political turmoil.
(Check out more on Opportunity Zones here).
Finally, even the most ambitious plan has hurdles ahead – first up, a hotly contested presidential race. Congressional races, consensus building and policy development lies ahead for the successful candidate and will be no small task regardless of who sits in the Oval Office.