Home Education What do Biden’s 1031 exchange limits mean for investors, the economy

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

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What do Biden's 1031 exchange limits mean for investors, the economy

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As part of President Biden’s budget for 2023, the administration has proposed severe restrictions on the so-called 1,031 exchanges.

Exchange 1031 is part of the IRS Tax Code, which allows real estate investors to defer taxes by sharing “similar” properties. The term “similar type” refers to the nature or character of the property. These properties should only be used for commercial purposes or as an investment.

The proposal provides for a deferral of income payments totaling up to $ 500,000 for each taxpayer ($ 1 million in the case of married persons filing a joint return) each year for such real estate exchanges. Any income from such exchanges in excess of $ 500,000 (or $ 1 million in the case of married persons filing a joint declaration) per year will be recognized by the taxpayer in the year in which the taxpayer transfers the real estate to be exchanged.

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Almost all real estate is the same to each other as long as it is used for business or investment purposes. For example, an apartment building can be exchanged for a warehouse, which can then be exchanged for an investment in a room for the elderly.

Negative impact

President Biden’s proposal will not only severely limit the value of property that investors can use in exchange, but will also negatively affect the economy as a whole. Although the proposal is intended to generate $ 1.95 billion in government revenue from property sales taxes, many people do not realize that taxes paid and related to businesses that use similar exchanges are already projected. will bring in $ 7.8 billion for the IRS last year, according to a study by Ernst & Young in May 2021.

In addition, the date of entry into force of the proposal on December 31, 2022 for completed exchanges is problematic. Since the owner has 180 days to identify and exchange the property, anyone contemplating a similar exchange in 2022 will essentially need to embark on this process over the next few months to reap the full benefits of traditional deadlines.

Some supporters of President Biden’s proposal may argue that the 1031 exchange primarily benefits the rich, and this will not affect middle-class investors because they are unlikely to exceed the corresponding limits of $ 500,000 and $ 1 million.

However, if the proposal is approved by the House of Representatives and the Senate, wealthy investors who are knowledgeable are likely to simply linger for property in return – expecting the tax code to change again in the future and restore a broader environment for 1031. exchanges. Their reluctance to sell real estate at the same time will lead to a slowdown in transactions and create an unintended effect of unrest in the real estate sector.

Expansive effect

The Ernst & Young study predicts that businesses associated with 1,031 exchanges will create 568,000 jobs, generate $ 27.5 billion in labor income and add $ 55.3 billion to GDP last year.

The 1031 exchange involves many parties, including real estate investors, escrow professionals, qualified intermediaries, financial lending companies, bargaining agents, Delaware statutory trust brokers, DST sponsors, and third-party reporting professionals. persons responsible for aspects such as appraisal, property conditions, property verification, reviews and due diligence. As a result, if exchanges are limited, as President Biden suggests, the negative impact will go far beyond potential sellers.

Finally, small businesses, which make up 80% of U.S. companies, will also be negatively affected.

For example, if a company owns a smaller property and wants to buy a larger one (or many properties) to ensure further growth, it will not be able to benefit from rising property prices and tax deferrals provided by similar types. exchange, thereby halting the potential expansion of the business.

The attempt to limit the tax deferral on the 1031 exchange is not new. So far, President Obama’s proposal for the 2016 budget has included limiting property deferrals to $ 1 million a year. Since section 1031 of the Tax Code has not changed significantly since the enactment of the Tax and Job Reduction Act in 2017, it is a natural goal for the Biden administration to generate additional revenue for the IRS.

However, in this case, the broad shortcomings of President Biden’s proposed restrictions on 1,031 exchanges clearly outweigh any possible advantages.

– Edward Fernandez, President and CEO of 1031 Crowdfunding

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