Our President and CEO, Kevin Long, recently gave a presentation on the Biden administration’s American Families Plan (also referred to as the Biden Tax Plan) and how eliminating 1031 exchanges will do more damage than good. “The most significant change to our investing infrastructure since the Deficit Reduction Act of 1984, which played with how we deal with long term investments in real estate, is the American Families plan put forth by the Biden administration,” Long stated, “The strength in our economy is consistency. The American Families Plan is putting not just a small deviation in our ship, but it’s probably a 30-degree turn.”
“From a real estate perspective, the Families Plan is really a tax hat trick for real estate. It affects us in three sections of the tax code: 1222, 1031, and 1014.” Many people who advocate in favor of the Biden Tax Plan don’t truly realize the enormous impact that these changes will make in their personal lives. Mr. Long goes on to mention, “The proposed changes to section 1222 actually increases the capital gains tax rate to 39.6%. That will be the highest it has ever been. As part of the affordable healthcare act, they added another 3.8% to capital gains taxes—we call it Net Investment Income Tax. Due to this addition, the effective capital gains tax is 43.4%.”
Doubling capital gains tax does not in turn double income or realized capital gains. “The logic that follows is that if we raise capital gains taxes from 15-20% where they sit today, and double it, that we are going to double our income. What Congress failed to effectualize is that real estate transactions and stock transactions are almost always transactions of choice. We choose when to take our capital gains.” There are patterns of this all throughout history, with one specific example being in 1968. “In 1968 they started raising capital gains taxes, and realized capital gains lessened dramatically until the tax rate came back down.”
Long conceptualized five unintended consequences of eliminating 1031 exchanges due to the Biden Tax Plan:
- Diminished quality of rental housing.
- Suburban sprawl.
- The cost of entry-level housing will increase.
- Decreased quality of life for our senior community.
- decrease in federal revenue from other avenues.
1031 exchanges are not for filthy rich individuals who are looking to evade taxation. “The misconception is that everyone believes 1031 deferments are for the filthy rich, but they’re not. They are for the regular person. We are the people who benefit from section 1031.”
Nobody thinks that a 401k or a Roth IRA is a bad idea. It’s good public policy and it encourages investment. So if that is true, then why do Congress and the Biden administration think that 1031 exchanges are so bad? They are philosophically the same thing.
“A Roth IRA or 401k is to stocks and bonds as section 1031 is to real estate. In both a Roth IRA and a 1031 exchange, you come into the initial investment with taxed dollars. You are able to trade stocks in an IRA or 401k without any tax on gains because you are encouraged to save for your retirement. In a 1031 exchange, you’re able to trade, not sell, your real estate without paying tax on gains because they want you to build your wealth. When you sell your stock and take the income out of your Roth IRA or 401k, you pay tax. When you sell your property or take income out via rent, you pay tax. They are the same policy.”
The retention of 1031 exchanges from the changes proposed by the Biden Tax Plan is crucial to the smooth operation and strength of our economy. It is the core of real estate transactions and makes significant contributions to both investors and everyday folks. Mr. Long concludes, “There is way more wealth in our retirement systems than there is in 1031 exchanges. If congress comes after the 1031 exchange, what’s next?”
Join us in our lobbying efforts supporting the retention of 1031 exchanges and visit 1031buildsamerica.org. Click “Take Action” to urge members of Congress to preserve section 1031.
Contact us if you are in need of a replacement property for your 1031 exchange or if you are interested in a safe, secure, and stable commercial real estate investment opportunity. millcreekcommercial.com