Many people assume that President Biden’s recently proposed “American Families Plan” that significantly reduces 1031 exchanges would only impact the top 1%. But the reality is that this plan would negatively impact smaller commercial real estate investors as well, by limiting their ability to roll over profits tax-free into a similar new real estate investment. The result could include a lot of unintended consequences, such as less appreciation for commercial real estate, less liquid markets and less price transparency.
“This could curb investors’ willingness to purchase new properties, lead to higher leverage on properties purchased in an effort to maximize returns or decrease investors’ desire to invest in and improve the assets they currently own,” BofA CMBS strategists Alan Todd, Mao Ding and Graham Voss wrote in their April 30 securitization note.
1031 Exchanges are Used by Investors Big & Small
1031 exchanges are used by smaller investors who buy modest properties that fly beneath the radar of larger commercial real estate firms. These like-kind exchanges allow investors to defer capital gains taxes when selling real properties by reinvesting the proceeds into new, like-kind replacement property.
“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,” BofA says. “An empirical analysis of exchanges reveals real property like-kind exchanges are associated with increased capital investment in the replacement property, reduced loan-to-value ratios (that reduces system-wide risk), and shorter holding periods.”
U.S. Department of Treasury Office of Tax Analysis estimated $37.56 billion in tax revenue will be foregone between 2020 and 2029 due to like-kind exchanges.
If smaller commercial real estate investors no longer buy these assets because of the limit on 1031 exchanges, the impact could be far-reaching and negative for the greater economy.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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