Stock Groups

What Biden’s proposed 1031 exchange limits mean for investors, economy

[ad_1]

manusapon kasosod | Moment | Getty Images

The administration proposed strict limits to the so-called 1031 Exchanges as part of President Biden’s 2023 budget.

Real estate investors can defer taxes through a 1031 Exchange. It is an IRS tax code that allows them to exchange “like-kind” property. A property’s nature and character is what the term “like-kind”, refers to. They cannot be used as investment properties or for business purposes.

For real estate exchanges of similar-kind, the proposal will allow for the deduction of gains above $500,000 ($1 million for married persons filing a joint tax). The taxpayer would recognize any gains made from exchanges of like-kind exceeding $500,000 or $1 million for married couples filing joint returns each year in the year that the taxpayer transfers the property.

FA Playbook: More

Let’s take a look below at the other stories that have an impact on financial advisor business.

As long as it’s used for business or investment, almost all real estate is similar in kind. An example is an apartment building that can be traded for a warehouse. This could be used to invest in senior living facilities.

Abverse effects

Biden’s proposal will not only limit investors’ ability to use property in an exchange but it could also negatively affect the entire economy. While this proposal is intended to generate $1.95 billion in revenue for the government through taxing the sale of real estate, many people don’t realize that taxes paid and related to businesses using like-kind exchanges were already projected to produce $7.8 billion for the IRS last year, according to a May 2021 study by Ernst & Young.

The proposal’s Dec. 31st 2022 effective date for complete exchanges makes it difficult. To receive all the benefits of the traditional 180-day exchange period, owners have to identify the property and exchanging it within two months.

Some might say that President Biden’s plan would primarily serve the rich, while it wouldn’t have an impact on middle-class investors as they are unlikely to surpass the $500,000 or $1 million limits.

However, if the proposal is approved by the House of Representatives and Senate, wealthy investors who are savvy would likely just hold on to property in response — expecting that the tax code will change once again in the future and restore a more expansive environment for 1031 exchanges. This would reduce transaction volumes and cause unintended ripple effects in the real estate industry.

Expansive effect

The Ernst & Young study projected that businesses related to 1031 exchanges would produce 568,000 jobs, create $27.5 billion of labor income and add $55.3 billion to GDP during the course of last year.

There are many people involved in the 1031 Exchange process. These include real estate investors as well as qualified intermediaries and finance companies. The negative effect of exchanges being limited, as President Biden suggests, would not only affect prospective sellers but also other potential buyers.

Finally, small businesses — which compose 80% of companies in the U.S. — would be adversely affected, as well.

A company might have a smaller home and want to acquire a bigger one or more properties to continue growth. However, this would prevent it from gaining the tax-deferral and real estate appreciation that a similar-kind exchange provides. This could impede potential expansion.

The idea of trying to limit the 1031 exchange tax deferral doesn’t seem new. The 2016 President Obama budget proposal contained a limit of $1 million per year on the real-estate deferral. Section 1031 is a target of the Biden administration in order to increase revenue for IRS. It hasn’t been subjected to major changes since 2017’s Tax Cuts and Jobs Act.

In this instance, however, President Biden’s proposal to limit 1031 exchanges is a huge drawback that clearly outweighs any potential benefits.

— By Edward Fernandez, president and CEO of 1031 Crowdfunding

 

[ad_2]