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Biden’s Tax Proposal To Limit IRS Section 1031 Exchanges

July 23, 2021
commercial real estate

You can view an updated version of this article here.

Real Estate Investors Beware

President Biden’s Green Book was released on May 28, 2021, and the tax reforms include a proposal to limit the deferral of gain on the exchange of real property used in a trade or business, or held for investment purposes, for real property of a “like-kind.” Deferral of gain would be limited to $500,000 for each taxpayer ($1 million for married taxpayers filing a joint return) each year for real property exchanges that are like-kind. Any gains from like-kind exchanges in excess of these limits would be recognized by the taxpayer in the year of the exchange. And with the maximum capital gains rate proposed to increase from 20% to 39.6%, the tax benefits of investing in real property are rapidly disappearing.

 

The Theory Behind the Proposal

The Biden administration’s theory is that the limits on deferred gain, plus increased capital gains rates, will increase government revenue by $19.6 billion over 10 years to help fund the administration’s objectives; but this estimate, if accurate, will fund only 1.6% of the $1.2 trillion infrastructure improvement plan.

 

What the Critics Say

One analyst (backed by research from accounting firm Ernst & Young, and by economists David Ling and Milena Petrova) found that a repeal of 1031 exchanges would likely:

  • Result in less federal tax revenue
  • Discourage real estate investment
  • Negatively impact the economy by up to $13.1 billion annually
  • Be contrary to the stated goal of tax reform

The National Association of Realtors points out that 1031 exchanges are necessary to keep the commercial real estate market progressing, and that 1031 exchanges are used primarily by retirees, investors and landlords, not by the super-rich.

 

Who Would Be Impacted?

It might surprise you to learn that the two asset classes under the most economic pressure due to the pandemic are also the two asset classes that would suffer the greatest detrimental impact from the elimination of 1031 exchanges – multi-family and retail. According to one study, multi-family assets have historically represented 51% of all 1031 exchanges, while retail assets have represented 16%. Moreover, if transaction volume is driven down due to the proposed 1031 limitations, that will have an adverse impact on real estate tax collections.

Summary

If the Biden proposal is enacted into law, it is expected to become effective for exchanges completed after Dec. 31, 2021. Investor’s sitting on sizable unrealized gain should move quickly to effect a like-kind exchange before the end of 2021.

If you have questions or would like to discuss further, please reach out to Steve Marrer at sam@kjk.com or 216.736.7267, or contact any of our Real Estate or Tax professionals.

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