President Biden released details of his $1.8 trillion American Families Plan, which proposes capping Section 1031 like-kind exchanges at $500,000 as a means to help pay for the plan.
While nothing is certain, of course, here’s what we know and what that could mean for real estate investors and developers across the country.
Let’s Rewind: Section 1031 Like-Kind Exchange Rules Now
Like-kind exchanges have been around since 1921. The strategy allows real estate investors to defer paying taxes on real estate by rolling profits into their next property — a continuity of investment concept.
Under the 2017 Tax Cuts and Jobs Act, like-kind exchanges were limited to exchanges of real property. Lawmakers aimed to close numerous “loopholes” but ultimately preserved like-kind exchanges for real property.
In response to this change, questions arose on what was defined as “real property” as there was no official definition at the time. In 2020, the IRS issued a much-awaited definition of “real property” and offered a safe harbor for taxpayers engaged in deferred like-kind exchanges who receive “incidental” personal property as part of their replacement property acquisition.
Fast Forward to the American Families Plan: Like-Kind Exchanges Are at Risk Again
Biden’s plan proposes to eliminate tax deferral for all like-kind exchanges with profits exceeding $500,000. While it is a relatively small part of the package of tax increases from Biden’s proposal, the Tax Foundation suggests that limiting like-kind exchanges could raise $7.5 billion a year.
If retained, the ability to use like-kind exchanges could become an extremely valuable tax planning tool, especially as capital gain rates and other deferral mechanisms are increasingly impacted.
What Happens Next?
This is currently just a proposal, and it would need to get through Congress and signed into law or through Budget Reconciliation before it could take effect. There are plenty of supporters for 1031s, so it is likely to go through a heated negotiation. For anyone considering like-kind exchanges or in the midst of one now, we suggest proceeding cautiously, as this proposal could impact you.
As always, your team at MGA will continue to follow the development of the American Families Plan and keep you updated along the way — always working hard to make the complex simple.
Have questions? Let’s talk!