Biden’s Proposed Changes to 1031 Exchanges May Impact Real Estate Market

President Biden’s proposed limits to 1031 exchanges have been met with mixed reactions. On one hand, the proposal aims to generate more revenue for the government and reduce wealth inequality by closing tax loopholes that benefit the rich. On the other hand, opponents argue that the limits will hurt small businesses and discourage investment in real estate.

For those who are not familiar, a 1031 exchange is a provision in the US tax code that allows individuals or businesses to defer paying capital gains taxes on the sale of an investment property by using the proceeds to purchase a like-kind property. This can be an effective way to grow a real estate portfolio and maximize profits. However, the proposed limits could significantly reduce the benefits of this provision.

Here are some of the disadvantages of Biden’s proposed limits to 1031 exchanges:

1. Higher tax burden: One of the main reasons why investors use 1031 exchanges is to avoid paying capital gains taxes on the sale of a property. Biden’s proposal would limit the amount of deferred taxes to $500,000, which means that investors would have to pay taxes on any gains above this amount. This could significantly increase the tax burden for investors, especially those who own multiple properties.
2. Negative impact on small businesses: Small businesses that rely on real estate investments could be hit hard by the proposed limits. These businesses often use 1031 exchanges to upgrade their properties, expand their operations, or relocate to better locations. If the limits are implemented, small businesses could face higher tax bills, which could affect their ability to grow and create jobs.  According to this article, “While this proposal is intended to generate $1.95 billion in revenue for the government through taxing the sale of real estate, many people don’t realize that taxes paid and related to businesses using like-kind exchanges were already projected to produce $7.8 billion for the IRS last year, according to a May 2021 study by Ernst & Young.”
3. Reduced incentives for investment: Real estate investors often use 1031 exchanges as a way to reinvest their profits into new properties, which can stimulate economic growth and create jobs. By limiting the benefits of this provision, Biden’s proposal could discourage investment in real estate and slow down the economy.  Investors would likely hang on to their existing properties which could further contribute towards a lack of inventory for sale and the low supply we are currently seeing in the Tampa Bay real estate market.
4. Increased complexity: Biden’s proposed limits to 1031 exchanges would introduce new rules and regulations, which could make the process more complicated and time-consuming for investors. This could discourage some investors from using the provision altogether, which would reduce the number of real estate transactions and the amount of revenue generated from them.

The proposal’s effective date of Dec. 31, 2022 for completed exchanges is problematic. Because an owner has 180 days to identify and exchange a property, anyone considering a like-kind exchange in 2022 would essentially need to initiate the process within the next couple of months to receive the full benefit of the traditional time frame.  In fact I am working with several investors right now who are scurrying to try to identify a replacement property in their 1031 exchange currently.

Biden’s proposed limits to 1031 exchanges have both advantages and disadvantages. While the proposal aims to reduce wealth inequality and generate more revenue for the government, it could also hurt small businesses, discourage investment in real estate, and increase the tax burden for investors. It remains to be seen how the proposal will be received by lawmakers and how it will ultimately impact the real estate industry.