What is a 1031 Exchange and Why Does it Matter?
A 1031 exchange, or like-kind exchange, lets you swap one investment property for another without triggering immediate taxes. Normally, property sales incur taxes, but a transaction that qualifies under Section 1031 of the IRS Code defers these taxes. This allows you to shift your investment while delaying capital gains tax, giving it time to grow.
There’s no limit to how often you can use a 1031 exchange. You can continuously move gains from one property to another until you sell for cash, when taxes become due. This process helps real estate professionals grow and diversify portfolios with minimal tax burden. To qualify, the exchange must involve real property used for business or investment, swapped for another like-kind property.
While 1031 exchanges don’t eliminate taxes, they delay them. This allows investors to grow their portfolios before paying taxes when they eventually sell the exchanged property.
Proposed Changes to Section 1031 Under the Biden Administration
The Biden administration has proposed limiting the benefits of 1031 exchanges. The proposal caps tax deferral at $500,000 for individuals and $1 million for married couples filing jointly. This cap aims to help fund the $1.8 trillion American Family Plan.
If Congress passes this proposal, any gains above these limits will face capital gains taxes. The plan also suggests raising long-term capital gains taxes for high-income earners, which could significantly increase the tax burden on wealthy real estate investors.
Impact of Proposed Changes on Investors
These proposed changes may lead high-net-worth investors to rethink their strategies. Many might consider alternative structures, like Tenancy in Common (TIC), to limit taxable gains. Removing or restricting 1031 exchanges could reduce real estate values and slow investment activity. Smaller investors, who rely on these tax deferrals to grow their portfolios, would feel this impact most.
The real estate market could also see shifts in behavior. Investors may adopt more complex tax strategies, slowing down reinvestment and overall economic growth.
Will Section 1031 Be Eliminated?
It’s unclear whether repealing Section 1031 would achieve Congress’s goals. Removing this tax deferral may not increase fairness or raise significant tax revenue. Instead, it could reduce property values, limit transactions, and even slow economic growth.
Keeping Section 1031, on the other hand, encourages reinvestment in U.S. communities and creates jobs. Like-kind exchanges drive activity in industries like real estate, construction, and finance. By preserving this provision, the economy continues to benefit from these transactions, while taxes are simply deferred.
Risks of Repealing Section 1031
If Congress repeals Section 1031, the real estate market could experience significant setbacks. Property values might drop, and fewer transactions could result in job losses across various sectors. The repeal would also tax cash flow rather than wealth, which could pressure business owners. Some may need to downsize if they can’t afford both reinvestment and the taxes on gains.
Conclusion
While changes to Section 1031 are under discussion, a complete repeal seems unlikely. The tax deferral provided by 1031 exchanges plays a crucial role in real estate growth and economic stability. Real estate professionals should stay informed, as any major reforms could significantly impact their long-term strategies.
Even after outlining all the information above, writing a letter of intent (LOI) can still seem daunting. That’s why the Leveraged CRE Team at Commercial Properties, Inc. is here to help locate commercial space for lease and assist in using a letter of intent to land such space. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.
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Meet The LeveragedCRE Investment Team
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