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Biden’s “American Families Plan” to raise gains taxes, abolish large 1031 exchanges

Wednesday evening, President Joseph Biden unveiled his next ambitious $1.8 trillion spending bill — dubbed the American Families Plan. Almost immediately thereafter, the real estate industry began sounding alarms over the proposal to substantially limit Section 1031 “like-kind” exchanges.

This is nothing new.

In fact, legislators target 1031 exchanges with some regularity.

Back in 2016, lawmakers from the then-victorious Republican Party tried to overhaul the Internal Revenue Code. Their initial package aimed to close several so-called “loopholes” — 1031 exchanges included among them. After some pushback from investors and other real-estate adjacent experts, the Tax Cuts and Jobs Act ultimately preserved like-kind exchanges for ‘real property’ (i.e. real estate).

 

Will the same happen this time? Nothing is certain of course, but 1031s have plenty of vocal supporters.

With that said, here’s what we know so far about the American Families Plan and 1031 exchanges:

A Delightful Discovery

Details are still emerging. We do know that the American Families Plan (AFP) purports to expand or create a host of domestic policies. This includes:

  • new services and credits for child care
  • publicly provided pre-K
  • mandated paid medical and family leave
  • publicly provided or publicly financed two-year community college
Coming on the heels of a $2.3 trillion infrastructure bill, which itself followed a $1.9 trillion COVID-19 relief bill, the AFP represents one of the most expensive spending packages in world history.

To partially offset the costs, the AFP would also:

  • substantially raise taxes on high-income earners (households making over $1 million)
  • increase in the top marginal income tax rate
  • increases in capital gains tax rates, with high-income households paying ordinary income tax rates on long-term gains
  • eliminate 1031 exchanges for any asset with $500,001+ in capital gains
  • eliminate the “step-up” in basis for gains in excess of $1 million
  • increase the corporate tax rate from 21% to 28%
  • eliminate the so-called “carried interest” practice for compensating fund managers in the private equity space
  • expanding the application of the 3.8% net investment income tax

How would this impact 1031 exchanges?

According to the White House summary, the American Families Plan would change the Internal Revenue Code to disallow any like-kind tax treatment under Section 1031 for real estate that has more than $500,000 in capital gains.

To the extent we have good data on this, a $500K cap is well above the average exchange value. Economic impact studies, most notably those produced by Barker, Ling, and Petrova, suggest the average market value of properties included in tax-deferred exchanges is less than $500,000.

Those in the commercial real estate space are more likely to be effected, since commercial assets are, on average, larger and more valuable than residential assets.

This will also more likely affect properties that are part of multi-exchange events (e.g. selling a property that was acquired as part of a prior 1031 exchange).

Of course, more details will emerge over time.

What Happens Next?

The proposed bill needs to be workshopped through Congress and ultimately signed into law before it could take effect.

With narrow margins in the House and Senate, it’s likely that any proposed plan would be subject to serious revision in order to keep all Democratic legislators on board. Experts do not expect any Republican lawmakers to support the AFP.

When Would the American Families Plan Take Effect?

There are rumors that changes to 1031 exchange eligibility would be made retroactive (that is, apply to exchanges that are processed in 2021 or earlier).

While there is some precedent for retroactive tax applications, 1031X could find no evidence to support this rumor.

If passed in 2021, the most likely outcome would be for changes to be made effective in January 2022 or January 2023.