A recent read of the Biden/Harris tax plan reveals a $4 trillion tax hike, and one of the considerations for funding this massive tax increase is a change of 1031 Exchanges.
President Biden’s administration has proposed eliminating 1031 “like-kind” exchanges for investors with annual incomes of more than $400,000, as part of a plan to fund future government spending on childcare and elderly healthcare.
1031 exchanges have been a part of the U.S. Internal Revenue Code since 1921. The law was originally passed by congress to stimulate economic growth. They allow real estate investors to defer capital-gains taxes when they sell properties by directing the proceeds into new investments, usually within a few months after the sale. As written, the rule allows investors to perpetually roll over capital gains into successive replacement property purchases, effectively eliminating tax liabilities through estate planning.
Throughout U.S. history, investors have relied on real estate as a means of generating both income and capital appreciation. Low investment returns and stock market volatility have converged to create enormous demand for income-producing real estate that is often used to fund future liabilities.
Now, more than ever, investors are looking to their real estate holdings to diversify away from market risk and provide a steady stream of income during retirement. For many 1031 exchange investors, their real estate holdings make up the largest portion of their net worth and are a key pillar in retirement planning.
In light of potential policy changes and evolving tax reform, a possibly even bigger question is will commercial real estate investors be able to utilize 1031 tax deferred exchanges as a means of buying and selling properties in the future?
This is not the first time that attempts have been made to eliminate 1031 exchanges but so far it continues to survive threats of repeal because lawmakers generally understand its positive impact on the economy.
As Brad Watt, CEO of Petra Capital said, “eliminating exchange rules at a time when the economy is suffering from the coronavirus pandemic would deal a ‘one-two punch’ to real estate values. 1031 exchanges benefit the “everyday” man by allowing smaller and less capitalized real estate investors to increase their income and net worth by temporarily deferring tax on reinvested real estate sales proceeds.”
Eliminating 1031 exchanges from the current tax code could have a profound negative impact on future real estate values and the economic prosperity of the many small investors who own investment property. For investors looking to sell their current investment property, there has historically been a long line of willing buyers. Investors have been eager to purchase stabilized income property with the added benefits of tax-sheltered income and the ability to protect future capital gains by utilizing 1031 exchange rules.
Now with the twin-threat of coronavirus and looming tax reform, sellers and buyers of investment properties are beginning to recalibrate pricing and income expectations. Now, more than ever, investors are relying on the stability of their real estate holdings to hedge against an unstable and unpredictable economy. You can read more here.
You can be sure that we will be watching this issue closely. We will absolutely keep you updated on the 1031 exchange and all policies that affect real estate. The market is in full swing, our team is always here for you!