Understanding How Biden’s Proposed Budget Impacts 1031 Exchanges

Biden’s Budget on 1031 Exchanges 

The US Department of Treasury released their General Explanations of President Biden’s FY 2025 Budget, also referred to as the “Green Book”, which proposes hard limits be set on IRC Section 1031. The proposed budget suggests that 1031 Exchanges are a loophole, as they delay the payment of tax on real estate transactions as long as the Exchanger continues reinvesting in real estate. It is believed that this equates to an interest-free loan from the government, potentially indefinitely, and real estate is the only asset that gets this “sweetheart deal.” The proposal would permit deferrals of gain up to an aggregate amount of $500,000 for individuals ($1 million for married couples filing jointly) annually for similar real estate exchanges. Any gains from 1031 Exchanges above $500,000 (or $1 million for married couples filing jointly) in a year would be recognized in the year the Exchanger transfers the real property and subject to tax.  

Effect on 1031 Exchanges 

If a $500,000 cap on 1031 Exchanges were to be implemented, research shows it would have negative economic consequences. Below are a few of the many reasons why a $500,000 limit on 1031 Exchanges would be harmful to the economy: 

Impact on Real Estate Investment and Liquidity: In real estate transactions, 1031 Exchanges are often utilized to defer capital gains taxes, motivating property owners to reinvest in other properties. However, setting a cap of $500,000 on these exchanges might hinder investors' ability to engage in larger and more complex transactions, potentially reducing liquidity in the real estate market. 

Reduced Property Transactions: A limit might dissuade property owners from engaging in 1031 Exchanges due to the potential of increased tax burdens. Consequently, this could lead to a decrease in property transactions, in turn, slowing economic activity within the real estate sector. 

Potential Negative Effect on Small Businesses: Setting a limit on 1031 Exchanges could have a negative, disproportionate impact on small businesses, as well as investors who depend on 1031 Exchanges in managing their property portfolios. Biden’s cap could hinder investors’ means to expand, relocate, or optimize their property holdings.  

Impact on Economic Growth: 1031 Exchange research shows that they stimulate economic growth by promoting investment, job creation, and improvements to properties, thus improvements to neighborhoods, cities, etc. Setting a hard cap on 1031 Exchanges would impede these economic accelerators.  

A microeconomic study conducted by Professors Ling & Petrova tracked 1.6 million properties over 20 years. It concluded that if 1031 was either limited or eliminated, transactional activity in real estate would decrease, cost of capital would increase, and GDP would contract. For example, elimination of Section 1031 would increase rent prices by approximately 6%. In further defense of 1031 Exchanges, Ernst & Young found in 2021 that Section 1031:  

• Supported approximately 976,000 jobs  

• Created $48.6 billion of labor income  

• Added $97.4 billion to US GDP 

All of this related economic activity returns over $13 billion in taxes annually for the Federal, State, and Local treasuries. On top of that, 1031 Exchangers pay an extra $6 billion in federal income taxes because they forgo depreciation on their replacement properties. Together, this equates to almost $20 billion of tax revenue per year. 

Benefits of 1031 Exchanges  

The benefits of 1031 Exchanges are not isolated to one sector of the American economy. On the contrary, 1031 Exchanges benefit individuals and businesses of all shapes, sizes, and values.   

Section 1031 helps Exchangers by allowing companies to keep cash in their businesses. It lets investors change their property ownership to match their current needs without being stuck with outdated setups. Limiting tax restrictions helps properties to be used in the most efficient way and reduces friction for real estate owners and their businesses.  

1031 Exchanges Create Jobs 

1031 Exchanges create job opportunities for various professionals such as contractors, skilled tradespeople, lenders, Qualified Intermediaries (QIs), title insurers, escrow companies, surveyors, building material suppliers, and more.  

Revitalization of Neighborhood and Increase in Affordable Housing 

Exchanges also help low-income, hard-hit, and distressed communities where outside sources of capital are less available. Properties exchanged by REITs and institutional investors have the expertise to take on the larger projects such as repurposing malls, hotels, and office buildings that were shuttered because of the pandemic.  

In addition, roughly 40% of like-kind exchanges involve rental housing. Section 1031 plays a crucial role in bridging financing gaps for affordable housing. Unlike the low-income housing tax credit, developers can utilize Section 1031 to fund land acquisition expenses for new affordable housing initiatives.  

Result of Budget Proposal 

The President’s budget projects that capping 1031 Exchanges would generate $1.86 billion in annual revenue. However, considering that tax revenue from 1031 Exchanges is roughly ten times greater than the projected revenue from limiting them, it is mathematically clear that restricting 1031 Exchanges would be an ineffective and counterproductive measure. 

Industry Support of 1031 Exchanges  

In April, much of the 1031 Exchange industry will come together at the Federation of Exchange Accommodators (FEA) Midyear meeting in Washington, D.C., to provide education on 1031 Exchanges. Members of the FEA’s Government Affairs committee will convene at the nation’s capital to speak with members of both the Senate Finance Committee and House Ways and Means Committee on the importance of keeping 1031 Exchanges in their current form.  

Accruit, an Inspira Financial company, is proud to be among this group. Accruit’s CEO, Brent Abrahm, will be joined by Steven Holtkamp, CFO and FEA board member, Max Hansen, Managing Director, and Jonathan Barge, Senior Director, to ensure our clients’ interests are well represented to our legislature.  

In conclusion, President Biden's FY 2025 Budget proposal moves to limit Section 1031, threatening to cause negative effects on the real estate market, as well as the economy. As leaders in the industry, Accruit will rally together with colleagues to lobby in support of IRC Section 1031. It is important for policymakers to consider the broader implications and critical role 1031 Exchanges play in strengthening economic stability. 

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.