Biden's Proposed Tax Plan Has Major Implications for CRE Investors
President Joe Biden has proposed a $1.8 trillion American Families Plan which will be funded in part by tax code changes that will directly affect commercial real estate investors.
The most notable proposed change is the elimination of the 1031 exchange, which has existed since 1921. The 1031 tax code allows real estate investors to defer paying capital gains on property sales by reinvesting the proceeds into other properties within six months of the sale. The Biden proposal would eliminate 1031 exchanges on profits exceeding $500,000.
The 1031 exchange is a cornerstone of commercial real estate investing; according to an estimate made by the Congressional Joint Committee on Taxation, like-kind exchanges may save investors $41.4 billion in taxes from 2020 to 2024. And according to data from the National Association of Realtors, these investors are not who you might expect. Approximately 84% of properties involved in 1031 exchanges were owned by small investors, indicating that this policy change will be far-reaching.
If Biden’s proposal is enacted, market liquidity will take a big hit. 1031 exchanges incentivize investors and encourage real estate activity; therefore, the elimination of the tax break would cause the market to stall out as investors hold onto their properties in hopes that the policy will change with the next administration.
As if the proposed changes to Section 1031 aren’t impactful enough, Biden also plans to raise the capital gains tax to 39.6% for individuals making more than $1 million per year. This tax hike would further solidify a slowdown in the market; not only would high-earning investors lose the opportunity to defer capital gains, but the capital gains they would be responsible for would increase almost 50%.
It’s difficult to predict if these tax code revisions will be implemented, or to what extent, but I’m advising my clients to start preparing for changes. If the Biden proposal is approved, I anticipate an influx of inventory as investors rush to transact properties before the changes go into effect, and then I expect the market will slow down or even freeze.
Justin Langlois, CCIM is a Commercial Real Estate Investment Advisor with Stirling Properties servicing Baton Rouge, Louisiana and surrounding markets. Please reach out to Justin to discuss your real estate investment strategies.