In yesterday’s article, we defined capital gains and the Section 1031 exchange. In addition, we also provided an overview of the various steps in a 1031 exchange. In this article, we will discuss what the future of the 1031 exchange may look like under a new administration so that you may plan accordingly. Prior to the election, President Biden made it very clear that he would seek to eliminate this important tool for real estate investors. In addition, with the Democrats controlling both the House of Representatives and now the Senate, this possibility becomes even more likely. Of course, this could potentially not come at a worse time, particularly for commercial real estate investors in areas such as hospitality.
The COVID-19 effect
With a recent resurgence in COVID-19 cases, it seems as though the new administration will be more focused on health and economic stabilization. Needless to say, you do not need to be an economist to know that removing the 1031 exchange during this fragile economy would be a particularly bad idea. While anything can happen, it appears unlikely that Congress would take the necessary steps to remove the 1031 exchange for now. By facilitating liquidity, 1031 exchanges are particularly important for business owners or individuals that do not have access to financing from larger institutions. Furthermore, the increased turnover in properties due to 1031 exchanges can also help create jobs as potentially new businesses are started.
The Section 1031 like-kind property exchange has been a part of real estate since 1921. One of the benefits of this exchange is that it gives ordinary people added flexibility and liquidity that they normally would not have. As a matter of fact, a recent economic study in 2020 found that as much as 20% of commercial real estate transactions over the last decade relied on 1031 like-kind exchanges.
Unfortunately, there is a stubborn misconception from the current administration that believes the 1031 exchange is a loophole used primarily by ultrahigh net worth individuals and corporations to avoid paying taxes. This could not be further from the truth. In fact, recent data shows that 63% of 1031 exchange properties are eventually sold in a taxable transaction at a later date. Of course, it’s impossible to determine what real estate transactions might have occurred – or not – without the 1031 benefit.
In closing, the 1031 exchange is an important part of real estate investing and the economy as a whole. By keeping money flowing through real estate investments, 1031 exchanges stimulate and support a variety of jobs in the sector, ranging from title company employees to appraisers to contractors who are hired when people buy and improve properties. Without this investment tool, more property owners would opt to sit on their properties leading to less turnover and ultimately, less jobs. If the Biden administration’s goal is to revive the economy, create jobs, and bring back business and consumer confidence, getting rid of 1031 exchanges would be a tremendous step backwards. We do not foresee this happening in the near future, at least during the pandemic.