A potential change to the Internal Revenue Code that President Biden touted during his campaign last year just moved a giant step closer to reality. The 100-year-old IRC Section 1031 may be headed to the gallows, and participants across all sectors of the real estate industry are preparing for a fight.
On Wednesday, April 28th, the President introduced his American Families Plan Act, a sweeping piece of legislation designed to expand government support of education, childcare, lower health care costs, and paid leave, among other proposed benefits. The $1.8 trillion Act would be funded partly by increasing taxes on the wealthiest U.S. citizens and reducing/eliminating specific tax-advantaged programs, like the 1031 exchange.
Many have written about the 1031’s imminent demise since Biden campaign officials introduced the idea in 2020. And worries among real estate developers, investors, and owners have steadily risen as the industry awaits more detail. Now we have that.
Proposed 1031 Exchange Revisions
While details of the President’s proposed changes to what he has referred to as “that special tax break,” administration officials have said the intent is to eliminate 1031 exchanges in cases where the gains in appreciated property values are greater than $500,000. That would appear to target wealthier investors, but in states with strong property values like California, many mom-and-pop investors who own an individual property or two could lose the tax deferral benefit.
Little else has been revealed about the administration’s intended changes to the 1031 exchange other than the $500,000 appreciation cap, but President Biden will assuredly face opposition in Congress from republicans.
Resistance is Mounting
A coalition of over 30 industry trade organizations – including powerful constituencies like The American Farm Bureau and National Association of Realtors – sent a letter to treasury secretary Janet Yellen in March, making the case that 1031 exchanges are a vital part of the country’s economic well-being. According to Suzanne Baker, co-chair of the lobbying group, Federation of Exchange Accommodators:
“Section 1031 encourages real estate transaction activity and, in doing so, is a powerful stimulator for the U.S. economy. Targeting 1031 exchanges reflects a misguided view of the actual purpose and benefits of like-kind exchanges.”
A study conducted by Ernst & Young on the potential economic impact of repealing the 1031 exchange would result in less federal revenue and shrink the U.S. economy by up to $13.1 billion annually. Expect the administration to dismiss this 2015 study as dated and irrelevant. Still, Republicans will undoubtedly use it to defend their position that 1031 exchanges positively impact vast swaths of the economy. So, what is the likelihood, President Biden will earn passage of the Act?
Will the Proposals Pass
As mentioned, the President’s plan to modify/eliminate the 1031 exchange will face fierce opposition in both the House and Senate. Now that the American Families Plan Act has been introduced to a joint session of Congress, the House will begin drafting the legislation. Republicans may unilaterally vote against the Act, especially because it includes tax increases.
President Biden could pursue the option of passing the plan through the budget reconciliation process with a simple Senate majority, which he used to pass the American Rescue Plan Act earlier this year. Should he choose that route, he is likely to foster an even more divisive political Washington D.C. Also, it is not a certainty the President can use budget reconciliation since specific requirements need to be met and approved by the Senate parliamentarian to ensure this legislation would be eligible.
Time to Act?
Not surprisingly, our team at Bangerter Financial has seen 1031 exchange activity pick up as uncertainty around the program’s future intensifies. We see areas where demand far outstrips supply – a trend we expect to continue as the legislation is drafted and debated.
If you own investment property and are uncertain how you may be affected by changes to the 1031 exchange, give us a call at 916-965-1879, and we will provide a no-cost review of your specific situation. And please continue to follow our article as we will be watching the progression of the American Families Plan Act quite closely.
You Can Make a Difference!
Contact your legislators by completing this simple form at https://www.1031taxreform.com/take-action/ and tell them your stories about the positive impact the 1031 exchange has had on your ability to help generate income, grow and preserve your wealth potential and even leave a legacy for your children. Your voice matters and needs to be heard now!
This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
There are material risks associated with investing in real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.
Investment advisory services offered through Bangerter Financial Services, Inc. A state Registered Investment Advisor. Registered Representative and securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Bangerter Financial Services, Inc. is independent of CIS.