As part of a multi-part infrastructure spending plan, President Biden has proposed capping Section 1031 like-kind exchanges by disallowing taxpayers from utilizing 1031 exchanges if their gains exceed $500,000.
Repealing the 1031 exchange provision would harm real estate investors of all sizes by forcing them to forego new investments or go into debt to finance their transactions. On top of that, it would also fail to raise significant revenue.
What are 1031 Exchanges?
1031 exchanges allow taxpayers to defer taxes on their capital gains if they reinvest those earnings in a new replacement property. Section 1031 has existed in the tax code for 100 years. Because investors don’t have to pay tax until they cash out, Section 1031 eliminates a potential barrier to investment, which promotes a more efficient allocation of capital resources.
1031 Exchanges are NOT a Tax Loophole
Critics of 1031 exchanges falsely claim that they are a loophole that allows taxpayers to avoid paying taxes. This is not true. The 1031 exchange provision defers rather than eliminates tax liability. A taxpayer that utilizes Section 1031 will eventually have to pay taxes on the asset when they cash out.
This tax deferral period is often shorter than many assume because taxpayers do not utilize 1031 exchanges indefinitely.
How do 1031 Exchanges Benefit the Economy?
There are significant benefits to the tax deferral offered by 1031 exchanges. Recent studies have found that 1031 exchanges provide taxpayers with liquidity that they can use to invest and create jobs. By providing additional liquidity, 1031 exchanges allow investors to avoid taking on debt and becoming over-leveraged. This also helps with the financing of new real estate projects, promoting a competitive and affordable housing market.
1031 exchanges are typically used for smaller real estate transactions. According to the National Association of Realtors, 1031 exchanges were used in roughly 12% of real estate sales. Almost 85% of these transactions were from smaller investors such as sole proprietorships or S corporations.
Repealing 1031 exchanges would increase holding periods as taxpayers would be encouraged to retain assets longer to avoid paying capital gains taxes.
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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