Biden's Proposes $500,000 Cap on Section 1031 Like-Kind Exchanges

31 Replies

The Federation of Exchange Accommodators (FEA) yesterday issued the following comment in response to President Biden’s American Families Plan, which proposes capping Section 1031 like-kind exchanges at $500,000:

President Biden has released the details of his $1.8 trillion American Families Plan, which includes a $500,000 cap on like-kind exchanges as a means to pay for the proposal. We now have a direct threat to Section 1031. According to the attached document released by the White House:

“The President would also end the special real estate tax break -- that allows real estate investors to defer taxation when they exchange property -- for gains greater than $500,000...”

FEA has been preparing for this threat for the past two years. We have built a strong defense with the 1031 real estate coalition, updated economic studies, multiple congressional fundraisers and numerous meetings with congressional staff. We will continue to fight to preserve Section 1031 in full as Congress considers the American Families Plan.

Following are some things you can do to help with Section 1031 advocacy efforts:

Send a letter to Congress: An UPDATED grassroots letter is available for you to send to your members of Congress urging them to preserve Section 1031. You can access the letter on the take action page of the 1031taxreform.com website: Tell Congress: Section 1031 Like-Kind Exchanges Matter (1031taxreform.com)

Talk with your contacts about preserving Section 1031. Below is a comment on President Biden's proposed cap that GAC co-chairs have given to members of the news media. Please feel free to utilize these comments as you talk with your own contacts about President Biden's proposal.

Comment from the FEA on President Biden's proposed $500,000 cap on Section 1031:

“The FEA opposes the Administration’s proposal to limit IRC Section 1031 like-kind exchange deferral to a maximum of $500,000 of gain, as a means to pay for the American Families Plan. We view this proposal, which would effectively eliminate commercial real estate exchanges, as well as larger farm and ranch exchanges, as a misguided view of the actual purpose and benefits of like-kind exchanges.

“Section 1031 encourages real estate transactional activity, and in doing so, is a powerful stimulator of the U.S. economy. Section 1031 is not an unfair or abusive loophole. It is broadly used by taxpayers ranging from middle class individuals exchanging rental houses and small apartment buildings, farmers, and small to mid-sized businesses, to larger taxpayers exchanging large commercial properties in major metropolitan areas.

“Smaller exchanges create a stable inventory of decent, affordable housing for working families. Section 1031 encourages turnover and investment of fresh capital in these properties, improving neighborhoods and providing decent places to live. Studies have shown that 1031 buyers invest significantly more capital in replacement properties than do non-1031 buyers.

“Higher valued commercial real estate exchanges are an important source of jobs for contractors, skilled and unskilled blue-collar workers, lenders, real estate brokers, Qualified Intermediaries, title insurers, escrow companies, surveyors, appraisers, architects, landscapers, building material suppliers and more. The income earned generates tax revenue and consumer spending, furthering the economic impact.

“Recent research by EY has estimated that like-kind exchanges are expected to generate 568,000 jobs this year, including $27.5 billion of labor income and a total of $55.3 billion of value added to the US economy. The economic impact of like-kind exchanges in their present form is a far better “pay-for” than eliminating this powerful stimulus.”



@Celia Moore Thanks for posting the info here.  I think many saw this coming, but couldn't determine what form it would take.  The idea being formalized as limiting the 1031 in value is probably more palatable to many than removing it completely.  I also think the number used at least here looks to show that it would only hurt "the rich".  I don't mean to make this political but that is where our country is at right now.  As much as I look to optimize my taxes and think everyone should, I am a fan of flat tax no deductions.  It's easier to accomplish, enforce, monitor and regulate.  

My biggest questions are:

Is that $500K limit per transaction or per person per year?

Does this put upward pressure on the current market for those trying to beat the possible tax burden?

How much does this incentivize people to hold much longer and probably do less maintenance? 

@Jonathan Stone my understanding is that the limit proposed is per asset.  That is, you can sell two different properties with $450,000 in gains each across two different exchanges, but not a single asset with $550,000 in gains. 

Of course, all we have is the White House summary sheet to work from.  

When this was telegraphed last year, the working paper suggested a $400,000 income limit for executing exchanges.  It's interesting that they've changed the criteria. 

Of course, the FEA and its allies across the country will be working diligently to preserve 1031s in their entirety. 

@Sean Ross great comment! They way we look at it is, you're just going to end up having a bunch of big sales compressed into little sales over a series of transactions... it will be very interesting to see what happens. This is something totally different than anything they have said in the past, and if they are looking at a $500,000 exclusion on gain in a single transaction, you can imagine that we are now going to have a whole bunch of micro-closings any time a large asset sells in order to satisfy the cap. 

The $500k number is also interesting because if you look at the universal exclusion for a married couple, it's also at $500k. In 1997 that meant something... today that means nothing.  

@Jonathan Stone yes, I do think so.  Or, at least the American Families Plan as a whole might. 

The increase in gains taxes on those earning high incomes means that anyone selling a highly priced asset -- whether investment or otherwise -- could find themselves loaded into a significantly larger tax bill.  

The AFP also appears to expand the application of the NIIT tax. 

Combined with the elimination of high-gains 1031s, this could convince a lot of taxpayers to start and complete new exchanges or move into new homes this year.

@Jonathan Stone great questions... we believe the cap is per transaction, and that this is sort of a shot across the bow at the Republican Party to bring them to the table. But it sounds as though a realistic expectation would be to see a 25% capital gains tax rate not just on depreciation recapture as it is today, but on both.... appreciation and depreciation. We will see which way it goes! 

@Celia Moore Thanks so much for sharing these resources. I have heard from several colleagues as well that lobbyists have been successful keeping 1031 exchanges  from being axed time and time again. 

Wouldn't it be entertaining to see how creative REI's can get with minimizing/avoiding this tax legally? For example, those of us who have taken a salesperson course know that real estate comes with a "bundle of right", meaning there is more than one single aspect to a piece of real estate. I wonder if instead of selling the entire bundle of rights to a $2,000,000 property all in one transaction, as is customary, a creative attorney/title agency could be hired to carve up the bundle in to 5 distinct sales?

1) Water rights

2) Mineral rights

3) Occupancy and use rights

4) Right to encumber & lease

5) Residual rights not contained in items 1-4.

Sell each right for $400,000 over a period of time.  Not sure how/if that would fly, but gets the creative juices flowing.

The IRS has an answer for those who would break up a large transaction into a lot of small ones: it's called the step transaction doctrine.  

Funny how no one seemed to care that in the last tax bill in 2017 that they eliminated 1031s for nearly all investments already. Complete silence. 

@Russell Brazil I am not sure where you were in 2017 but we definitely fought on that one! Collector cars used to be my favorite type of Exchange. Thankfully we kept Real Property off the chopping block for Exchanges last time around... and hopefully it will be remain that way. 

@Erik W. it would definitely be interesting to see what they come up with! I had no idea about the "bundle of right"... but love to hear the creative thinking. This stuff is not black and white, there is gray involved.

Capping an exchange at a $500k gain (not asset value) will only affect who it's suppose to.  

My guess is more than 90 out of 100 on here will never get there and syndicators will pass the cost along to stakeholders.  They're good at that already.

@Steve Vaughan I had the same thought. This sounds like it's targeting the gain, not the asset value. If that's correct, it is going to affect a smaller swath of properties. I'm just glad it's shifted from an income based qualification to an asset qualification. That said, I'd still like to see it shot down or the cap raised even further, say $1M.

Originally posted by @Bonnie Low :

@Steve Vaughan I had the same thought. This sounds like it's targeting the gain, not the asset value. If that's correct, it is going to affect a smaller swath of properties. I'm just glad it's shifted from an income based qualification to an asset qualification. That said, I'd still like to see it shot down or the cap raised even further, say $1M.

At least we're having a conversation and negotiation about it.  

I think $500k in deferred gain per transaction is fine, personally.  My exchange last year saved me $62k in federal taxes and that gain and recapture was only about $280k.  I appreciate the deferral and fully redeployed into something larger like we're suppose to. 

A deferred gain of $500k on one transaction will probably be tops for me in my career anyway.   Even if $100-$200k was taxed at current rates as boot, I'd still survive. 

Getting the gov to spend effectively may be a different matter, but I'm happy to contribute a little gravy to infrastructure, green or the less fortunate.  The cap will affect those it is intended to IMO.  Hedge funds, syndicates, private equity, etc. 

 

Originally posted by @Steve Vaughan :
Originally posted by @Bonnie Low:

@Steve Vaughan I had the same thought. This sounds like it's targeting the gain, not the asset value. If that's correct, it is going to affect a smaller swath of properties. I'm just glad it's shifted from an income based qualification to an asset qualification. That said, I'd still like to see it shot down or the cap raised even further, say $1M.

At least we're having a conversation and negotiation about it.  

I think $500k in deferred gain per transaction is fine, personally.  My exchange last year saved me $62k in federal taxes and that gain and recapture was only about $280k.  I appreciate the deferral and fully redeployed into something larger like we're suppose to. 

A deferred gain of $500k on one transaction will probably be tops for me in my career anyway.   Even if $100-$200k was taxed at current rates as boot, I'd still survive. 

Getting the gov to spend effectively may be a different matter, but I'm happy to contribute a little gravy to infrastructure, green or the less fortunate.  The cap will affect those it is intended to IMO.  Hedge funds, syndicates, private equity, etc.  

This is making me think the people most affected could be people like my mother who have a couple of properties that they hold for extended periods of time creating over time with massive appreciation over 30+ years.  If they want to 1031 as they move to a hands off asset they may be stuck with a large tax bill as they approach retirement.

 

It might make me sell something a little early.  Personally I don’t think they should have ever had the 1031.  It was created to help the Kennedy fortune, I believe.  Seeing what it has become and how much it has been used along with stepped up basis it does feel like the system favors investors at least to me.. 

That being said I will be shocked if the Democrats can pass it unless they create some other loophole for the dynasty/ultra wealthy families. 

@Eric Bilderback

I see it as an incentive for investors to keep using their capital to improve the lives of those in their market.

Doesn't matter the party, government has never managed money effectively. They have to print 50% of all the money they spend.

@Dillon Cook

Agree it is a great incentive to reinvest your capital.  But the fact is you have to invest in something and I love investors I am an investor but the apartment buildings I own would still be there and the place would be pretty similar if I owned or didn’t own them.  While I agree government is inefficient what alternative is there to investing in real estate?  Wal Street is a bunch crooks and sellouts.  I could get even more cynical and point out all the poor people who are displaced when investors gobble up deals all over their neighborhood and start putting in Whole Foods and breweries.  But I won’t.  LOL



I agree that this new cap on  1031 exchange will not affect many investors. $500k in gains is probably 5% or less of 1031 transactions. If anything, it will lead to more transactions as people will be trading up in property more often to avoid accruing 500k in gains. I dont really have a problem with it if it passes or dies. 

Originally posted by @Jonathan Mueller :

I agree that this new cap on  1031 exchange will not affect many investors. $500k in gains is probably 5% or less of 1031 transactions. If anything, it will lead to more transactions as people will be trading up in property more often to avoid accruing 500k in gains. I dont really have a problem with it if it passes or dies. 

I agree, Jonathan.  A small swath of individuals may be affected a little, but the cost/benefit of capturing the intended hedge and equity funds and syndicates is worth it.

Yet we will hear from folks who think their parents may be affected (but probably won't).  It's the same as only getting a $500k gain exclusion on primary residences.  Those rat pastures only let me have $500k tax free and my gain was $680k. I should have traded up 5 years ago but didn't and had to pay taxes on $180k.  Woe is me!

Regional differences matter.  In my part of California, there have been essentially no real estate transactions in the last 3 years involving less than $500K.  Most involve substantially more.  With depreciation recapture, every 1031 exchange is going to be taxed out here if I understand the proposed rule correctly.