- Joe Biden wants to stop investors from benefiting from the 1031 exchange, according to his recently announced economic plan.
- The exchange, also called a ‘1031 transfer,’ is popular with property owners, and often saves real estate investors hundreds of thousands of dollars in deference on capital gains tax upon the sale of a property.
- To qualify for a 1031, you have to use the proceeds of one sale to buy another, certain kind of property.
- The tax code has been targeted by both Democrats and Republicans over the years, and its repeal could mean the loss of more than $50 billion for real estate investors over five years, per the congressional Joint Committee on Taxation.
- It’s an especially beloved strategy for real estate investors like President Donald Trump.
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Joe Biden is threatening to end a real estate tax benefit worth billions: the 1031 exchange.
The idea to ditch this section of the tax code, often used by real estate investors, was mentioned with the release of Biden’s economic plan. The Real Deal reported that the billions generated by repealing the benefit would support Biden’s “caring economy plan,” which calls calls for universal preschool for 3- and 4-year-olds and a child care tax credit of up to $8,000 for middle-class families and lower, among other things.
The 1031 exchange used to apply to more than just real estate transactions, for instance it used to be applicable to things like machinery, equipment, vehicles and patents, according to the IRS.
The entire provision was targeted for removal by both Democrats and Republicans in the 2017 tax code overhaul, per The Wall Street Journal, but real estate developer President Donald Trump signed a package that kept it intact for real property.
If successfully removed from the tax code under Biden, it could mean the loss of over $50 billion for real estate investors over a five-year period, according to the congressional Joint Committee on Taxation.
So what is this part of the tax code that is (again) facing the chopping block?
How does a 1031 exchange work?
In most property transactions, taxes are a sure thing. But investors can avoid a big tax hit from the IRS the next time they sell a property as long as they buy something else first.
The so-called 1031 exchange, named for a specific section of the IRS code and sometimes called a “like-kind exchange,” is a provision that gives investors the ability to defer capital gains taxes from the sale of an investment or business use property, as long as a like-kind asset is purchased with the sale’s profits.
Put more simply, the 1031 allows you to make smart property investments without owing a massive bill to the IRS.
The exchange is a strategy for investors looking to swap one asset for another, or for any investors interested in avoiding a capital gains tax of, depending on your bracket, up to 20%.
What that means for an investor is often hundreds of thousands in immediate tax savings, and a chance to redirect an investment strategy to maximize profitability.
A high-maintenance rental in an expensive city like New York, for example, could be exchanged for a series of lower-maintenance investment properties in more savings-friendly states with lower costs of living.
Rules to keep in mind
Strict rules dictate 1031 eligibility having to do with the timing of sales and purchases, as well as the types of properties that qualify for use. While these are important to keep in mind throughout the exchange process, consulting a lawyer and understanding all the IRS fine print is a critical step towards making the most of your tax benefits and keeping up to date with IRS regulations.
Here’s a few of the main things to consider.
The 1031 doesn’t apply to personal property.
The exchange only applies to business or investment assets, not personal homes. In other words, you can’t use a 1031 to sell your condo and move to a single-family home.
The exchange must be performed along a narrow timeline.
After the sale of the first property, a replacement property must be identified within 45 days of the original sale or the exchange is forfeited and the transaction becomes subject to capital gains.
After the 45 day identification window, 135 days are left to close on the new replacement property or properties.
Altogether, this means the investor has about a month and a half to identify their new property, and about six months to close.
Both properties must be “like-kind” to qualify.
“Like-kind” properties, according to the IRS, are simply ones of similar nature or character, without consideration of quality. For example, the sale of a multi-family apartment complex in New York for a similar multiplex in North Carolina would be acceptable.
Market values and titles must match.
Names on tax returns and titles for both properties must match. The net market value of the newly purchased property must meet or exceed the value of the property being sold as well.
Both properties need to be in the US.
For a successful exchange, the IRS mandates any properties involved in the transaction be located within the US.