When President Joe Biden introduced the American Families Plan, it included a host of other programs, including universal preschool, free community college, and national paid parental leave. One of the questions surrounding this proposed Plan includes a natural question about the requisite tax changes that have been proposed to pay for the Plan, which currently has a price tag of roughly $1.8 trillion. While none of the proposed changes have been approved or instated, the ‘if yes, what then?’ question is particularly interesting for the commercial real estate sector as a whole.
An Overview of Section 1031
The proposed elimination of 1031 exchanges is one of the changes that’s seen the most feedback and conversation sector-wide. Section 1031 of the Internal Revenue Code has a long history in the real estate industry. It was first introduced as part of the Revenue Act of 1921, allowing a tax-free swap of properties that are held for business or investment purposes. There are a lot of regulations regarding which properties qualify in what time frame and with what rules, but 1031 exchanges are still used frequently by investors to change the form of their investment while deferring capital gain taxes. This strategy is so common among investors in the real estate world that the title ‘1031’ is very widely understood by even novice real estate investors.
Biden’s new economic plan, if executed in the way the administration has proposed, would include the abolishment of a real estate investor’s ability to defer that capital gain tax. This comes as part of an effort to raise taxes on wealthier individuals to bring the plan to fruition. But since like-kind exchanges are such a popular investment strategy, the changes would hit all types of real estate investors, from large commercial real estate investors down to smaller-scale, highly involved landlords.
In their May blog post, UBS touches on this point briefly, mentioning that the 1031 exchange has been part of the commercial industry landscape for a long time, and that its elimination could lead to a significant decrease in transaction volumes and price discovery, a negative outcome for the commercial real estate industry.
The Biden administration also proposed an increase to the top personal bracket, up 2.6%, and an increase to the dividends tax rate for households making more than seven figures. They mention changes to the tax rate on carried interest, inherited assets, and the amount of tax on earnings that goes toward Medicare for households above an income threshold.