American Families Plan & Impact on 1031 Exchanges
The Biden Administration has proposed several tax policy changes in recent weeks to raise $1.5 trillion in revenue to cover new subsidies for families and workers as part of the American Families Plan. Several of these proposals could dramatically impact the real estate market.
Limiting 1031 Exchanges
The Plan proposes a limit to IRC Section 1031 like-kind exchange deferral to a maximum of $500,000 of gain.
The Federation of Exchange Accommodators in conjunction with coalition partners commissioned two economic studies showing the economic value of 1031 exchanges.
Among other findings, these studies conclude:
• §1031 exchanges will support 568,000 jobs and $27.5 billion of labor income in the United States during 2021.
• Like-kind exchanges will generate $55.3 billion in value added in the United States in 2021. Given that it is likely that total volume of exchange activity is underestimated, value added could be as much as $69.1 billion.
• Taxpayers engaged in like-kind exchanges (LKEs), along with suppliers and related consumer spending will generate approximately $7.8 billion in federal, state, and local taxes during 2021.
-Of that, $4.965 billion is federal, and $2.805 billion is generated at the state and local level.
-Additionally, an average of $6 billion per year of additional income taxes are paid due to foregone depreciation on the replacement property acquired in the exchange.
• Eliminating LKEs would create a lock-in effect resulting in fewer transactions and price declines. Without the ability to exchange, taxpayers would continue to hold on to sub-optimal assets which in turn would exact a cost on the economy - properties would be more highly leveraged and owners would spend less on capital improvements.
Links to these studies and information on how to contact your local officials can be found here: 1031taxreform.com - A Section 1031 like-kind exchange reform resource
Additional Tax Provisions
The American Families Plan proposes raising the capital gains tax rate from 20% to 39.6% for those making $1 million or more; and includes eliminating the “step up in basis.” A “step up in basis” allows heirs to use the fair market value of an asset at the time of inheritance rather than the original purchase price as the basis for capital gains when the asset is sold. In other words, if the asset has a lot of built in gain, a step up in basis allows for that gain to be eliminated at the time of the owner’s death. This proposal includes a $1 million dollar exemption (“$2.5 million per couple when combined with existing real estate exemptions”), an exemption for donations to charity, and “protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the busines.” The details of these protections are not yet clear.
The Plan also includes the following potential provisions:
• Raising the top individual income tax rate from 37% to 39.6% - This was the previous level prior to the 2017 Tax Cuts and Jobs Act (“TCJA”)
• Closing the “carried interest loophole” so that “hedge fund partners will pay ordinary income rates on their income”
• Eliminating rules that allow taxpayers making over $400K to avoid the 3.8% Medicare tax on earnings and net investment income
• Permanently extending the 2017 TCJA provision, section 461(l) that restricts the deductibility of active pass-through business losses to $250K/$500K
• Providing additional IRS funding to focus enforcement activities on large corporations, businesses, estates, and higher-income individuals