What the White House release means (education is going to be key), what it doesn’t (1031 is ending), and whether it’s time to panic (not exactly).
On March 9th, 2023, the White House released a statement outlining plans for the Biden Administration’s budget for the 2024 fiscal year. Titled, “FACT SHEET: The President’s Budget Cuts Wasteful Spending on Big Pharma, Big Oil, and Other Special Interests, Cracks Down on Systemic Fraud, and Makes Programs More Cost Effective,” the statement covers many important issues, but of special note among them is that the administration plans to change Section 1031 of the tax code, which covers like-kind exchanges.
Here is a brief rundown providing answers to Frequently Asked Questions about what’s in the statement and what it means for anyone planning a 1031 exchange now or in the future.
1. What does the Biden budget proposal say about 1031?
The relevant portion of the statement reads:
Eliminate Tax Subsidies for Real Estate. The Budget saves $19 billion by closing the “like-kind exchange” loophole, a special tax subsidy for real estate. This loophole lets real estate investors – but not investors in any other asset – put off paying tax on profits from deals indefinitely as long as they keep investing in real estate. This amounts to an indefinite interest free loan from the government. Real estate is the only asset that gets this sweetheart deal.
Without naming Section 1031, the administration makes it clear that it plans to “eliminate” this portion of the tax code, a major change for a tax deferral option that has existed for more than 100 years.
2. Isn’t that what they said last year?
Not exactly. The administration’s 2023 budget proposal included a cap on capital gains on which taxes could be deferred, “up to an aggregate amount of $500,000 for each taxpayer ($1 million in the case of married individuals filing a joint return) each year for real property exchanges that are like-kind. Any gains from like-kind exchanges in excess of $500,000 (or $1 million in the case of married individuals filing a joint return) a year would be recognized by the taxpayer in the year the taxpayer transfers the real property subject to the exchange.”
While the proposal for 2023 was to limit 1031, it appears from this new statement that in 2024, the administration wants to do away with it completely to eliminate what it calls “an indefinite interest free loan from the government” and a “sweetheart deal.”
3. Is that a fair assessment of 1031?
Hardly. The main thrust of the “sweetheart deal” argument is that investors in other assets can’t take advantage of it. What the statement leaves out is that for most of 1031’s history, investors in other assets could take advantage of 1031. Only since 2017 has 1031 applied only to “real property.” If it’s the unfairness that the administration has a problem with, why not put things back the way they were and allow more people to take advantage of 1031?
The unstated argument implied by this move is that 1031 is only for wealthy developers, allowing the rich to escape paying taxes. As we’ve covered before, 1031 can be employed by small business to help them grow and can be an important component to retirement planning, making it far more than just a tax tool for the rich or industry insiders.
This statement leans less on the “tax break for the wealthy” angle and more toward the “real estate loophole” angle possibly because they think the public’s distaste for the real estate industry will drive support. It remains to be seen how the move will be spun, but it’s telling that they’ve chosen this particular phrasing this time around.
4. Why go after 1031 now?
It’s been well-documented that 1031 exchanges can actually lead to greater tax revenues in the long run. Those in the industry know that tax deferral is not tax evasion, and that ending or restricting the program could have harmful effects on the US economy – so why make 1031 a target right now?
Note some of the other major proposals contained within the statement: eliminating tax subsidies for oil and gas, closing the carried interest loophole, limiting the amount taxpayers with incomes over $400,000 can hold in tax-favored retirement accounts. Regardless of how you may feal about any of these moves individually, what they all have in common is that they will increase tax revenues in the short term.
From the point of view of maximizing tax revenues, eliminating Section 1031 seems to be a short-sighted decision. However, it likely would cause an increase in revenues in the short term, which is why it fits with other elements of the proposal.
Not your first 1031 Exchange? Learn more by visiting our 1031 Exchange Guide!
5. Does this mean 1031 is ending?
No. The proposed budget has yet to be released. We don’t know if a resolution ending 1031 will appear in the 2024 budget or not, or what the exact language will be. After that, there will be plenty of debate before Congress approves the budget, and anything related to 1031 is likely to change during that time.
Remember that the Biden Administration has suggested changes to 1031 before, and they didn’t come to fruition. It’s possible they’re suggesting eliminating 1031 now because their efforts to change it in the past have failed, and they’re hoping to settle on a cap as a compromise. It remains to be seen what the final resolution may look like, or if anything will change at all.
6. What is likely to happen next?
Once the budget is officially released, Congress will debate it and changes will be made before it is passed. One thing we can count on is that members of Congress respond to their constituents, so education will be crucial for anyone who wants to preserve 1031. By demystifying a program that average voters might not know much about, we can increase support for leaving Section 1031 alone.
7. How can I prepare for the possibility of 1031 being eliminated?
It’s entirely possible that the FY2024 budget could do away with 1031, institute a cap, or some other change could be put in place. Uncertainty over potential changes may cause property owners to consider performing an exchange earlier than they’d originally planned.
If you’re thinking about performing an exchange in 2023 to get ahead of any possible changes next year, it’s important to understand the current real estate market and how it might affect your exchange. For many reasons, reverse exchanges may prove beneficial in the current real estate market, as could those involving Delaware Statutory Trusts. As experts in both these scenarios, JTC can help you successfully complete your exchange on time and in compliance with all rules.
8. What do I need to know to initiate a 1031 exchange in the near future?
Before performing an exchange, it’s important to familiarize yourself with all the rules, including the identification rules and 1031 exchange timeline. You’ll also need a Qualified Intermediary to hold exchange funds during the exchange. JTC has decades of experience as a QI, with tens of thousands of successful transactions. We pair our unmatched in-house expertise and attentive client services team with an online portal that offers 24/7 access to exchange information. Even if it’s been a while since your last exchange or you’ve never performed one before, JTC can help you do things right.