Biden’s Budget Proposal on 1031 Exchanges
The U.S. Department of Treasury has released the General Explanations of President Biden’s FY 2025 Budget, also known as the “Green Book.” This proposal includes significant changes to IRC Section 1031. The proposed budget outlines that IRC Section 1031 allows for "no gain or loss to be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." Currently, 1031 exchanges permit the deferral of taxes on real estate transactions as long as the proceeds are reinvested in similar property, which some view as an indefinite, interest-free loan from the government.
Proposed Changes and Implications
The proposed budget suggests capping the deferral of gains at $500,000 for individuals and $1 million for married couples filing jointly, per year, for like-kind exchanges. Any gains above these amounts would be recognized and taxed in the year the property is transferred.
Impact on 1031 Exchanges
Effect on Real Estate Investment and Liquidity: Capping deferrals could hinder investors' ability to engage in larger transactions, reducing liquidity in the real estate market.
Reduced Property Transactions: The potential increase in tax burdens may discourage property owners from utilizing 1031 exchanges, leading to a slowdown in property transactions and economic activity within the real estate sector.
Negative Impact on Small Businesses: Smaller businesses and investors, who rely on 1031 exchanges to manage property portfolios, may face disproportionate challenges. This could impede their ability to expand, relocate, or optimize their holdings.
Impact on Economic Growth: Research shows that 1031 exchanges promote economic growth by encouraging investment, job creation, and property improvements. Imposing a cap would likely reduce these positive effects.
Research and Industry Support
A study by Professors Ling & Petrova tracking 1.6 million properties over 20 years concluded that limiting or eliminating 1031 exchanges would decrease transactional activity, increase the cost of capital, and contract GDP. Additionally, Ernst & Young found in 2021 that Section 1031 exchanges supported approximately 976,000 jobs, created $48.6 billion in labor income, and added $97.4 billion to the US GDP. The related economic activity returns over $13 billion in taxes annually to federal, state, and local treasuries, with exchangers paying an additional $6 billion in federal income taxes due to forgone depreciation.
Benefits of 1031 Exchanges
1031 exchanges offer widespread benefits, allowing companies to reinvest capital, optimize property use, and reduce transactional friction. They create jobs for various professionals and contribute to the revitalization of distressed communities. Around 40% of like-kind exchanges involve rental housing, playing a crucial role in financing affordable housing projects.
Conclusion
President Biden's FY 2025 Budget proposal to limit Section 1031 exchanges threatens to have negative effects on the real estate market and the broader economy. It is vital for policymakers to consider the broader implications and the critical role that 1031 exchanges play in economic stability. Accruit, along with industry colleagues, will advocate for the preservation of IRC Section 1031 in its current form.
The material in this blog is presented for informational purposes only. The information provided is not investment, legal, tax, or compliance advice.