Biden’s proposal would solve a long-standing tax loophole
President Biden’s new economic plan would eliminate a tax break for many real estate owners that allowed them to defer payment of capital gains on real estate sales.
Closing this tax loophole, which has existed since 1921, is part of its $ 1.9 billion spending plan for new social programs. Current law allows investors to defer payment of real estate gains tax if they reinvest the proceeds in other properties within six months of the sale.
The transactions are known as 1031 exchanges, named after the section of the U.S. tax code. The Biden proposal would eliminate 1,031 trades on real estate profits over $ 500,000.
In theory, the capital gains tax from these transactions ends up being paid. But on the advice of estate planners, many real estate investors continue to buy and sell properties this way until they die, passing the capital gains on to their heirs tax-free upon death. Mr Biden is also seeking to close the death loophole by taxing capital gains on inherited assets.
A U.S. Congressional tax committee estimated that the 1031 tax break would save real estate investors more than $ 41 billion between 2020 and 2024.
In the plan released by the White House on Wednesday, the Biden administration argued that the real estate loophole is one of many on the books that disproportionately allows the very rich to avoid tax. “Without these changes, billions of capital income would continue to escape tax entirely,” the administration said.
Mr Biden’s proposal would also increase the maximum rate paid on capital gains and dividends to 39.6% from 20%, and increase the taxes hedge funds pay on deferred interest.
Real estate investors say the 1031 tax treatment encourages businesses to grow, create jobs, and pump more money into the economy, especially during times of downturn in overall economic activity, such as recessions .
Most of the 1,031 deals are done by individuals rather than corporations, according to a report by the Congressional Joint Committee on Taxation. They have been popular with high net worth investors who pooled money to buy smaller apartment buildings, motels, or other types of cheaper commercial real estate.
They are also favored by private commercial real estate companies. Publicly traded real estate investment trusts, or REITs, have less need of trades because they enjoy other tax benefits.
Dozens of organizations have signed up to pressure the federal government against the repeal of 1,031 exchanges, according to Senate lobbying disclosures, including the American Farm Bureau Federation, the National Association of Realtors and the Asian American Hotel Owners Association.
Southern California-based shopping center owner Sandy Sigal oversees a $ 2 billion real estate portfolio. During his 35-year career, he said he had done around 50 exchanges, which gave him more money to grow his business.
He sold a mall in Baldwin Park, Calif. Last year and then reinvested the proceeds by buying and redeveloping another mall. He said during difficult times like the pandemic, these tax swaps helped him generate more business and hire more workers than he otherwise would have.
“Would we have done this without [a 1031 exchange]? No, we would have kept the money, ”Sigal said.
A whole cottage industry of brokers and advisers also exists to facilitate these niche transactions, which would also be threatened by a change in the law. The dark line of the tax code even has its own lobby group, the Federation of Exchange Accommodators.
“Section 1031 encourages real estate transactional activity and in doing so is a powerful stimulus to the US economy,” said Suzanne Baker, group co-chair, who opposes the Biden proposal.
The tax treatment also applies to residential sales, allowing sellers of housing to defer their capital gains by reinvesting the proceeds of the sale in housing other than their primary residence. Biden’s proposal would continue to allow 1,031 trades under $ 500,000, meaning many homeowners and small investors could still benefit.
Originally, trade applied to other forms of personal property, such as works of art or machines. These types of properties were eliminated by Congress and President Trump in 2017, in an attempt to offset other significant tax cuts they enacted. Real estate exchanges have been preserved.
Write to Will Parker at [email protected]
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