As real estate investors are exposed to the most dangerous and uncertain investment scenarios in recent times, it is likely that Democratic presidential candidate Joe Biden will twist the knife and put real estate investors in more trouble.
Last month, in his campaign, Biden proposed putting an end to the Internal Revenue Code’s Section 1031 exchange, also known as a like-kind exchange, from the tax code as an attempt to raise approximately $775 billion in new spending on elder and child care in the coming decade. In his speech in Delaware, Biden told people that his tax plan would be applicable for real estate investors with net annual income over $400,000, ending unproductive tax cuts and creating job opportunities in other industries.
What Biden is not willing to understand — or maybe he does — is that scrapping Section 1031 from the tax code would make things more problematic for the real estate industry already on the verge of collapse due to coronavirus pandemic, with rents and unpaid mortgages and high vacancy rates piling up throughout the entire country.
Scrapping 1031 exchanges would not only significantly impact liquidity in the real estate market, but it would also eliminate new investments. Biden’s decision would also reduce the number of taxed real estate investments and may even fail an increasing number of properties and lead to bankruptcies and potential bank failures.
Moreover, scrapping this so-called tax loophole would apparently raise only a handful of money Biden wishes to gather for elder and child care, at the cost of a vital engine of the real estate market by extension.
Section 1031 of IRC or 1031 exchanges let real estate investors defer capital gains tax on the sale of investment properties by reinvesting the sale proceeds into another property. The exchange opportunity applied to investors having different assets, such as planes and cars, until 2017, when the creators of the Tax Cuts and Jobs Act eliminated Section 1031’s application to all property types, except real estate, to offset the TCJA’s reduction in the private and corporate income tax rate.
As per Congress’s Joint Committee on Taxation, 1031 exchanges are projected to save $51 billion between 2019 and 2023 for real estate investors. This figure represents a massive chunk of necessary liquidity in the real estate market, which would undoubtedly be lost if Biden eliminated Section 1031.
Besides, scrapping 1031 exchanges would almost lead to an overall reduction in taxable real estate investments. According to the National Association of Realtors, nearly 40% of all real estate investments from 2011 to 2014 would not have occurred if there was no Section 1031.
Eliminating 1031 exchanges would put investors and distressed funds on the sidelines, causing even more trouble for distressed buildings, and leaving banks with mortgages that will never be paid back, which may lead to catastrophic bank failures.
Biden characterized Section 1031 exchanges as a tax loophole that benefits only affluent real estate investors. However, at best, it could be said disingenuous and, at worst, a blatant falsehood. Millions of Americans invest in real estate, and several small corporations depend on exchanges to achieve efficient growth in the revenue.
Nor is it true that Section 1031 lets real estate investors avoid taxes on their investments; 1031 exchanges only allow tax-deferment temporarily. As per one of the studies in 2015, around 90% of real estate investors eventually sell properties acquired in Section 1031 exchanges and pay taxes on those sales.
Briefly, a robust tax policy is essential in determining how the U.S. reshapes its economy during and post COVID-19 pandemic. At least, the Democratic presidential candidate, Joe Biden, should again consider the numbers and continue Section 1031 exchange provision for real estate investors.
An abrupt change in tax policy presently, especially one that significantly impacts the purchase and sale of real estate, could severely damage the still-recovering U.S. economy.