Biden’s Plan to 86 the 1031 – Will It Send Real Estate Reeling?

Biden’s Plan to 86 the 1031 – Will It Send Real Estate Reeling?

In times of confusion and discomfiting change, we look to great minds for direction and comfort.

As an old Concord boy, my go-to is Emerson.

“Our chief want in life, is, someone who shall make us do what we can.” I could do without all those commas, but the 19th century moved at a horsebound pace. They had time for pauses; savoring words; breathers for reflection. Not us – we zoom on.

Let him speak more: “This is the service of a friend. With him we are easily great.”

Ralph Waldo had good friends, indeed: sparkling novelist Louisa May Alcott; beloved, be-bearded philosopher-lazybones Henry David Thoreau; Franklin Benjamin Sanborn – were do we start with him? Anti-slavery conspirator for a start. Concord, is, my kind of town.

So we need good friends to spur us to action. All writers, even pygmy blog scribblers, adore their readers, so forgive my presumption if I call you my pals. I want to be like RWE, encouraging you to do what you can with all that you have, as long as you’re able. Which leads us to politics, and real estate.

President Joseph Robinette Biden Jr. In imaginative pondering, hs name marks him a Jacobin firebrand – and who knows? Calming ourselves for the moment, we know one thing: he aims to spend. Paying for transformational plans requires casting a wide net to capture maximum tax take-in from wriggling fish who know all the tricks to get off the hook. Yet Joe, his common-man handle to friend and foe, seems a fisherman patient and truly determined.

Let’s talk about the 1031 exchange. Technically, the 1031 is a tax-deferred like-kind exchange. The popular moniker comes from IRS Code Section 1031, which sets the rules for dealmakers, whether aristocrat, sans-culotte or rank commoner.

Now, Robespierre Joe won’t guillotine the 1031 outright – he just wants it curtailed to prevent wealthier citoyens from benefitting quite so greatly from its provisions.

Originally, the rules applied to a broad set of transactions, but President Trump’s Tax Cuts and Jobs Act of 2017 wiped out all uses except for his darling – real estate. I thought that guy didn’t like taxes?

Real estate industry stats show that people of all income levels employ the 1031 to their benefit. The rules allow property investors to swap assets while deferring capital gains taxes. One property investment effectively becomes another without tax penalty, just as the original lawmakers intended. The governing statutes, launched in 1921 and amended into contemporary form in 1954, came about because the government feared that taxing capital gains on basically equal asset exchanges would inhibit active, productive investment. Sensible policy, but I wonder if the times are a-changing.

Biden’s proposal would prohibit the use of 1031’s provisions when a deal’s gains exceed $500,000, which they not uncommonly do in real estate. Don’t forget that President Joe is also inflamed to eliminate the step-up in basis. Investors can use the 1031 right up to their dying breath, when the step-up kicks in, wiping away all fears of capital gains tax. It would be wondrous, if only you were alive to see it.

If 1031 and the step-up are axed on the same platform, and the president has indeed proposed these reforms as a package, things could get expensive at inheritance time for heirs.

No one should lose their heads right this moment – can you say ha-ha with a French accent? – as nothing has happened yet, and the final result could be more friendly to investors. Yet a call right now to an estate planner should certainly be jotted on your blotter.

Simple in conception, the 1031 is demanding in execution, with arcane rules, strict timings, mandated intermediaries, myriad costs and punctiliously applied tax rules. Do it right and watch the tax man squirm; trip yourself up and you’re the worm on his hook.

If you are ruminating on an asset swap – you want to trade horse barns for corn farms, say, or an apartment block for a donut shop – the 1031 exchange might be your ticket. I’ve written on this before, so allow me to crib: when choosing your agent to facilitate the transaction, go for top-drawer, wood-paneled professionals. The 1031 doesn’t run at amateur hour, and only the finest can do the deal right.

Careful, though, as some old boots these days are too clever by half. Creative expensing is encouraged to keep earnings under Biden’s half-million threshold. Don’t go too aggressive, now: there could be a reckoning with the IRS, which has itself been aggressive of late, arguing arcane points of accounting law in courts nationwide. Nothing to excess, my honorary oi filoi – that’s Greek for ‘mates’. Steer a moderate course, away from Siren’s rocks.

Take care a bit more: some punters suggest breaking up real estate holdings into smaller lots for sale, to keep transaction earnings under Joe’s limit. I asked a real estate agent compadre what she thought of this stratagem. Martine gave me a Zoom-look: too complex, says M, inviting a court’s ruling ‘against’. She added dire words about “all that syndication crapola” and I lost the plot – but a qualified advisor will certainly get it.

Martine raised an alternative: a Section 721 exchange, where you swap real property for REIT units. “That stands for ‘real estate investment trust’, Tom,” said M, drawling my name. She knows I prefer ‘Thomas’. In South Asia, where I live, ‘Tom’ is a soup.

The 721 transaction is commonly called an UPREIT exchange. It isn’t as well known as the 1031, but it’s a nice way to diversify a portfolio. The problem with the 1031 is the slim window in place to complete it – no such problem with the UPREIT. As with 1031, you’ll need a qualified intermediary to grease the deal’s skids.

If a real estate deal is on your agenda, consult experts soon to see if these numbers fit your bill. In the time we have left, friends, please do all you can.

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