Democratic presidential candidate Joe Biden's proposed tax plan would eliminate 1031 exchanges for taxpayers making more than $400,000 annually. While this may seem like a reasonable cut to some people, it would actually have a devastating impact on the real estate industry and the economy as a whole. In this article, we're going to discuss why eliminating 1031 exchanges would be bad for the economy.
Negative Impact of Eliminating 1031 Exchanges
Dismantling section 1031 would be detrimental to the commercial real estate industry and the greater economy. Farmers, bankers, title closers, and real estate agents would all suffer. Some are saying that Biden's targeting of like-kind exchanges is politically motivated, as President Trump has personally benefited from using 1031 exchanges in his own businesses. While that may be true, it's not a good reason to completely eliminate like-kind exchanges of real estate because real estate is an engine that drives economic growth and job creation.
1031 Exchange History
The 1986 tax overhaul really decimated the real estate industry for years afterward. This proposal would have a similarly devastating impact. Pull tax incentives from real estate and watch the economic carnage that ensues. Section 1031 has been a part of the Internal Revenue Code for decades and has survived numerous legislative changes. In 2017, the GOP tax plan that was signed into law (The Tax Cuts and Jobs Act) eliminated personal property exchanges of items like aircraft, art, and business equipment, but kept intact the provision for 1031 exchanges of real estate.
Some commentators point out that unlike other investments that are untaxed while they are held, the value of real estate is constantly taxed during ownership through county and sometimes municipal property taxes, and taxed again on transfer through state deed tax or transfer taxes (which are based upon the value of the real property). Still other observers say that real estate is just plain more illiquid than other types of investments.
Consequences for the Real Estate Industry & the Economy
Real estate closings are really complicated and difficult, and it takes much longer to market, sell, and close real estate than other types of investments. Without the extra inducement of 1031, the number of sales will plummet nationwide as owners will be locked-in for tax reasons, and also from the practicality of liquidity difficulties. This will be further exasperated by a lack of potential buyers because there will be nobody trying to exchange-up to buy their properties. The result will be that sellers will either choose not to sell to avoid being penalized with taxes...or won't be able to sell because the underlying demand from purchasers will be anemic. Ultimately, this will lead to stagnation, lower property values, and inefficiency in the marketplace.
It's not like the commercial real estate industry is soaring right now. As a result of COVID, the industry has fallen to new depths, with hotels and restaurants (among others) facing an existential crisis. Tapping the real estate industry to pay for the debt accrued because of COVID would be akin to kicking a person when they're down. Wouldn't it make more sense to have another industry that's doing really well right now pay for these services?
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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