Are 1031 Exchanges Going Away in 2021?
A 1031 exchange is a swap of one investment property for another which allows capital gains taxes to be deferred. For investors to qualify, the exchange must occur between like-kind properties (a house for a house, a multifamily unit for another one, etc.). If executed correctly, the seller of a property will have his capital gains taxes deferred. Put simply, this is a wealth building tool with a major tax break. So, when you sell a property and buy a similar one, you can use all your original investment funds or add funds to purchase another property and pay no taxes when you sell – even the profit on the original sale is not taxed and can therefore be used toward a new purchase. Also, this investment tool can be used for multiple sales at the same time. There is no limit to the number of exchanges an individual or consortium can execute.
President Biden once indicated a possible end for 1031s. But today, due to the Covid driven struggling economy, it is unlikely that the president will want to hinder reinvestments which aid the macro economy. Quite the opposite, we need more investments now. Anything which propels investment (especially during a struggling economy) is important in terms of improving the economy. As an example, think of a restaurant owner who wants to sell his business and buy a larger space for an eatery. This would create new jobs, and those new employees will be paying taxes which would serve to strengthen the coffers of the treasury. An owner of a small neighborhood grocery store can upgrade over the years and eventually be the owner of a supermarket, which would require more employees, again aiding the job market.
The focus of the new administration in the near term is likely to be on vaccine distribution and proposing a major infrastructure initiative. And even if a proposal is brought to congress to rescind or narrow the 1031 exchanges, it would be unlikely to pass according to most pundits.
All of this is uplifting news for business owners, entrepreneurs, and commercial real estate investors. And as mentioned earlier, it is also good news for job seekers.
The 1031 is a particularly important tool for the small businessman who doesn’t have many of the tools and tax advantages when compared to big corporations.
In the last decade, it is estimated that about 20% of real estate transactions relied on 1031s.
For those who think this is just another tax loophole, consider the following: Exchanges are likely to lead to taxable events when owners finally cash out. Remember taxable profits are deferred, not eliminated. And according to a recent study, 67% of 1031 exchange property owners are eventually sold in a taxable transaction at a later date.
Of course, we cannot determine how many less real estate transactions may never have occurred without this benefit.
Another study by the largest accounting firm in the U.S., Ernst and Young, found that eliminating the 1031 benefit would cost the economy “an annual year after year decline in GDP of 27.5 billion.” The study also found that the annual revenue loss would be 13.1 billion. This would have an extremely negative impact on the overall economy. It would result in lower economic activity and, therefore, a decline in commercial real estate prices.
This would be bad news in normal times; it would be much worse during an economic slowdown. Many owners would simply sit on their properties, not wanting to take a tax hit. Another result would be more underutilized properties, more financially depressed neighborhoods, and fewer jobs.
Losing the 1031 benefit, in short, would be a self-inflicted wound on the economy.