Biden’s election win is bringing a wave of changes to commercial real estate, and one tax loophole for investors may find itself on the chopping block.
While on the campaign trail, Biden called for phasing out the 1031 exchange provision – known as the “like-kind” exchange – for investors whose incomes exceed $400,000.
The 1031 exchange dates back to 1921, when Congress authorized the first tax-deferred like-kind exchange, though the provision as it stands today was established in 1954. Since then, it has enabled investors to defer paying capital gain taxes from the sale of certain properties, as long as the proceeds are used to acquire a “like-kind” investment property of equal or greater value, allowing them to “upgrade” properties without the extra tax burden. The Joint Committee on Taxation projected the provision would save property investors $51 billion on capital gain taxes between 2019 and 2023, and the provision has also allowed them to claim write-offs for losses on borrowed money and claim depreciation on buildings, despite real estate typically increasing in value over time.
While reports swirled for decades about the threat of the “like-kind’ exchange being eliminated, the provision did face significant cuts under the Trump administration. Along with real estate, the 1031 exchange provision previously allowed capital gain tax deferral on other assets and property, including personal property, vehicles, art, equipment, and machinery, but was mostly eliminated with the Tax Cuts and Jobs Act of 2017. The exchange was left in place for real estate, with the specification that exchanges applied only to properties used for investment purposes and defined as “real property,” which includes residential, commercial, industrial, and retail rental properties.
But with Biden setting his sights on the path to recovery following the economic blow from the pandemic, closing this capital gains tax loop looks like a good way to raise revenue in response to the budget slowdown. Biden indicated that he wants to use the revenue raised to help fund a childcare and elderly care plan projected to cost $775 billion over 10 years, noting that it would be paid for by “rolling back unproductive and unequal tax breaks for real estate investors with incomes over $400,000 and taking steps to increase tax compliance for high-income earners according to “The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce.”
If you’re an investor making less than $400,000, your ability to take advantage of the provision is safe, for now. But should Biden’s plan come to fruition, the market could see an influx of sales and transactions as investors above the threshold move properties, taking advantage before the benefit ends, and with an anticipated slowdown once the proposed change takes effect. As The Business Journal reports, the Senate Finance Committee estimated in 2015 that eliminating the exchange would “shrink the economy by $13.1 billion annually” and investment would “decrease by $7 billion in the long-run and labor income would fall by $1.4 billion,” though estimations preceded the 2017 cuts to the provision.
Opponents to Biden’s proposals have claimed investors will be less likely to sell without the benefit and the need to account for that capital gain tax they’ve avoided for decades, leading them to hold on to properties for longer, resulting in less property tax revenue for local governments, as well as possibly driving these investors away from real estate and toward the stock market.
But there is still an opportunity to take advantage of capital gain tax deferrals through the Opportunity Zone program established under the Trump administration, incentivizing investments in projects to boost low-income urban, rural, and tribal communities. It’s a program for which Biden has expressed his support, but looks to reform to prevent high-income investors from exploiting the tax breaks in those zones to “pad their wealth.”
With pandemic-related relief at the forefront of current efforts, it appears unlikely the Biden administration will make any major moves soon, but for some, the question is not if Biden will implement these changes, but rather when.
If you’re an investor or property owner looking to capitalize on the 1031 exchange benefits before the program possibly ends, EBI Consulting's expertise can help as you look to sell existing and acquire new properties. Allow EBI to get you the information you need to make informed decisions and mitigate risk during real estate transactions. Our team of professionals can help you evaluate the challenges and risks associated with diverse property types, navigate the process of investing in commercial real estate, and offer actionable intelligence to make the best investment decisions and save money down the line.
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