President Joe Biden sent shockwaves through the real estate investment community in the summer of 2020 when he proposed key changes and restrictions for 1031 exchanges to fund an economic recovery plan titled, “The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce.”
Biden’s sweeping social agenda includes free preschool and subsidized child care, increased access to care for older Americans and people with disabilities, and pay raises for early childhood education teachers and child care workers.¹
Funding for the $775 billion, 10-year plan would come from rolling back tax breaks real estate investors have used for decades as part of their investment strategies. Read on to learn more about how 1031 exchanges landed in President Biden’s crosshairs and the pall of uncertainty the President has cast over the real estate investment community as a result.
Why 1031 Exchanges are Important for Retail Investors
1031 exchanges allow property owners to sell their real estate assets and defer capital and other gains taxes when they roll the entire sale proceeds over into similar or “like-kind” properties. Real estate investors are swapping one property for another without the benefit of taking out any profit, and it’s important to note that investors still must pay those deferred capital gains taxes when they divest their swapped properties.
1031 exchanges form the backbone of retail real estate investing. According to the National Association of Realtors (NAR), 84 percent of 1031 exchange properties from 2016-2019 were completed by small investors in sole proprietorships or S-corps.² Furthermore, the median sales price of exchange properties from 2018 through 2019 was $500,000, which demonstrates that investing in real estate is not just for well-heeled accredited and institutional investors.³
Exchanges also are crucial for the transfer of property ownership, the NAR reports. The median holding period for exchange investors was 8.5 years, but that number is predicted to spike if Section 1031 was repealed or altered from its current regulations. Additionally, 94 percent of Realtors expect property values to decline if investors lose the tax advantages that come with the ability to swap properties and trade up for potentially higher-equity investments or to diversify their real property holdings by asset class and geographical location. It’s also an important strategy for investors seeking to reduce property management duties by swapping multi-tenant assets for single-tenant properties.
Proposed Changes to Internal Revenue Code Section 1031
The 1031 exchange structure was formed through the Revenue Act of 1921 and has been used for more than a century as a tax-deferral and capital reinvestment strategy.
Biden’s proposed Section 1031 tax reforms would set an exchange limit of $500,000 annually for each taxpayer, a number that’s doubled for married taxpayers who filed a joint tax return. Any capital gains exceeding that amount would generate a tax liability for filers during the tax year the property was exchanged.⁴
There’s also a proposal for a steep hike in the capital gains tax. Currently, long-term gains are capped at 20 percent for high-income taxpayers, but the proposal would increase that limit to 39.6 percent.
The Bottom Line
The ultimate fate of 1031 exchanges remains up in the air, but certain developments have led investors, analysts, and experts in the commercial property industry to believe that like-kind exchanges have dodged a bullet.
Draft language of Biden’s 2021 American Families Plan made no mention of the restrictions and caps on 1031 exchanges first proposed in 2020. The administration is admittedly more focused on the pressing matters of ending the Covid-19 pandemic, boosting the economy, and immigration and health care reform.⁵
Although the initial shockwave has subsided into tiny ripples, millions of real estate investors and countless others in the commercial property industry are waiting and watching to see if 1031 exchanges will remain a target by the current administration.
1. Campaign Press Release – The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce, Presidency.UCSB.edu, https://www.presidency.ucsb.edu/documents/campaign-press-release-the-biden-plan-for-mobilizing-american-talent-and-heart-create-21st
2. Like-Kind Exchange Transactions of Realtors in 2016-2019, National Association of Realtors, https://www.nar.realtor/research-and-statistics/research-reports/like-kind-exchange-transactions-of-realtors%C2%AE-in-2016-2019
3. The Tax and Economic Impacts of Section 1031 Like-Kind Exchanges in Real Estate, David Ling and Milena Petrova, Sept. 2020, https://thediwire.com/wp-content/uploads/2020/09/Ling-Petrova_Like-Kind-Exchanges_RELKEC_09-03-20-final.pdf
4. Will 1031 Exchanges be Restricted by Congress?, Propmodo, https://www.propmodo.com/will-1031-exchanges-be-restricted-by-congress/
5. The Biden-Harris Administration Immediate Priorities, WhiteHouse.gov, https://www.whitehouse.gov/priorities/
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.There is no guarantee that companies that can issue dividends will declare, continue to pay, or increase dividends.