Hoping to increase revenues for the federal government, Joe Biden has proposed a variety of changes to the tax codes, including tax increases for top earners and a 1031 Exchange repeal.
One of the codes that could be eliminated is the “1031 Exchange,” which allows investors to avoid making tax payments on the sale of a property, as long as the money is re-invested into a similar or more-expensive property.
This code, which according to some sources could save property investors $51 billion in a four-year span, is considered an important part of the real-estate and investment industries. But, right or wrong, it could be on the chopping block.
But will it happen?
For that matter, why would Joe Biden want to eliminate a code that is considered, by some, to be so important.
Would he even have the power to do so?
What is 1031 Exchange?
The 1031 Exchange code is a way for property investors to sell a property and reinvest the funds without paying a capital-gains tax. When investors sell an investment for a profit, they are expected to pay a tax on those gains. For example, if you invest $50,000 in a company stock and sell the stock for $100,000 five years later, you are expected to pay taxes on the $50,000 profit.
Many investors own multiple real-estate properties, and some properties, quite frankly, are better than others. Investors will often sell the ones that are not making money or don’t fit their strategy, and if they make a profit on the sale, they are expected to pay a tax on the earnings. But what if you are not pocketing the cash, but instead rolling the proceeds into a new investment? With the 1031 Exchange, you don’t have to pay taxes as long as you roll the cash into a new property within a certain timeframe.
This tax code was created to support transactions and market activity, but, in the minds of some, it’s considered a tax loophole that only benefits wealthy investors.
Why Would Joe Biden Want a 1031 Exchange Repeal?
The motivation is simple: revenue. As we discussed above, the 1031 Exchange is expected to save investors roughly $15 billion over a four year span. Biden, hoping to raise revenues for a variety of government programs, especially childcare and elderly services, may eliminate the program in an effort to fund these issues.
There is also speculation that Biden is motivated to eliminate the exchanges because for reasons. This seems like a stretch, but a variety of sources hinted that Biden would chop 1031 Exchanges because they are so important to the Trump real estate business and eliminating them would give “Biden an opportunity to try to embarrass Trump for avoiding taxes.” Again, this is completely speculative, and it’s certainly not a motivation that Biden has voiced out loud.
The motivation to raise revenue, it seems, is far more plausible. (Whether it would raise revenue is another debate. It’s possible that by eliminating the tax break, exchanges and market activity would decline.)
Will it Happen?
President Biden would not be able to simply waive a magic pen and eliminate 1031 Exchange from the tax code. It’s far more complicated than that.
In the United States system, as part of the checks-and-balances that is so fundamental to our government, Congress, including the Senate and the House of Representatives, creates a tax bill that is sent to the president’s desk. The president can either sign the bill and turn it into law, or he can reject it entirely.
So eliminating the tax code would come down to creating a bill that both the House, which is narrowly controlled by Democrats, and the Senate, which has yet to be decided, agrees on. That tax code would then need to be sent to the president’s desk, and he would need to look it over and decide whether or not it’s worth approving.
So the process is complex. A lot has yet to be decided, and even if the Senate comes down to a split (which means VP Kamala Harris would hold the tie-breaker), eliminating 1031 would not be an easy prospect.
Also, the elimination of 1031 Exchanges has been proposed before and not made it to the president’s desk. Like many political statement, the motivation to take out 1031 could get bogged down in political tangles, leading it to die off before it even gets debated in Congress.
But it could still happen, and investors need to have a plan to deal with the situation if 1031 is repealed.
What Should Investors Do?
Some investors may not be particularly concerned with the repeal of 1031 Exchanges. Frankly, the real estate industry, while strong, is still dealing with a variety of other issues, and one could argue that worrying over the 1031 Exchange code is not a good use of your mental energy.
However, it never hurst to be prepared.
If 1031 gets set to be eliminated, investor strategy can take many different forms. But it seems that a good plan would start by identifying properties that would be candidates for offloading before the exchange is eliminates. Even if the law stays in placing, knowing which properties you would want to move will help expedite the process if it comes to that.
Even if 1031 stays, investors may want to consider removing properties and exchanging them for better investments right away. You don’t know whether the 1031 Exchange will exist in the future; you do know that it exists now. So why not take advantage of this tax code while you know it’s available?
Whether or not 1031 is repealed has yet to be decided. Even if the Democrats force a tie in the Senate, a single Senator diverging from the party agenda could make it impossible to eliminate 1031 Exchanges, so nothing is certain.
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