The Biden-Harris administration has introduced several policy proposals that have left many in the investment real estate industry concerned about the future. From potential changes to the 1031 exchange to increases in capital gains taxes to changing the step-up in basis rule that would affect family estates, the administration's approach has sparked debate and criticism, with some arguing that these policies could undermine the very foundations of the investment real estate sector. This article explores the reasons behind these proposals and the potential impacts on the industry.
The Administration’s Economic Agenda
President Joe Biden and Vice President Kamala Harris have made it clear that their economic agenda prioritizes addressing income inequality and ensuring that the wealthiest Americans pay their “fair share” in taxes. Central to this agenda is the belief that the current tax code disproportionately benefits wealthy individuals and large corporations, allowing them to accumulate vast wealth while contributing relatively little in taxes compared to their overall income.
One of the ways the administration seeks to achieve its goals is by targeting provisions in the tax code that are seen as favoring the wealthy, including those frequently utilized by real estate investors. The administration argues that reforms are necessary to create a more equitable tax system and generate revenue for social programs, infrastructure, and other public investments.
Key Proposals Targeting Real Estate
Several specific proposals have raised alarms within the real estate industry:
1. Elimination of the 1031 Exchange
As discussed earlier, the 1031 exchange allows real estate investors to defer capital gains taxes when reinvesting in similar properties. The Biden-Harris administration has proposed either eliminating this provision or severely restricting its use, arguing that it primarily benefits high-net-worth individuals and large real estate firms, although research shows it greatly benefits the middle-class and first time investors by allowing them to defer gains while building their real estate portfolio.
2. Increased Capital Gains Taxes
Another significant proposal involves raising the capital gains tax rate. Currently, long-term capital gains are taxed at a lower rate than ordinary income. The administration has proposed increasing this rate for those earning over $1 million per year, bringing it closer to the rate on ordinary income. This change would directly affect real estate investors, who often rely on capital gains from property sales to fuel further investments.
3. Changes to Estate Tax Policies
The administration has also proposed changes to estate tax policies, including altering the step-up in basis rule, which adjusts the value of inherited assets to their market value at the time of the original owner’s death. This rule currently allows heirs to minimize or avoid capital gains taxes on inherited property. Removing or modifying this rule could lead to substantial tax burdens for those inheriting real estate, potentially forcing the sale of family-owned properties to cover tax liabilities.
Why the Administration’s Stance Could Harm the Real Estate Industry
Critics argue that the Biden-Harris administration’s approach could severely damage the real estate investment sector, with ripple effects throughout the broader economy.
1. Discouraging Investment
The proposed changes to the 1031 exchange and increased capital gains taxes would reduce the incentives for real estate investment. If investors are unable to defer taxes or face higher tax burdens on their gains, they may be less likely to buy and sell properties, leading to a slowdown in market activity. This reduction in transactions could have far-reaching consequences, including fewer opportunities for economic growth and job creation in related industries like construction, property management, and real estate brokerage. While its argued these changes would only harm wealthy earners, there's no doubt it would harm all real estate investors big and small.
2. Depressing Property Values
By discouraging investment, these policies could also lead to a decrease in property values. Real estate markets thrive on liquidity and investor confidence; policies that create uncertainty or increase costs for investors could lead to lower demand, and thus, lower property values. This depreciation would be felt most acutely in markets that rely heavily on investment activity, potentially leading to a broader economic downturn.
3. Disproportionate Impact on Smaller Investors
While the administration's policies are aimed at wealthy individuals and large corporations, smaller real estate investors could bear the brunt of these changes. Many small and medium-sized investors rely on tools like the 1031 exchange to grow their portfolios and achieve financial stability. Increased taxes and reduced opportunities for deferral could force these investors out of the market, consolidating power in the hands of larger players who have a myriad of tax strategies at their disposal and ultimately reduce competition.
4. Negative Consequences for Local Economies
Real estate investment is a significant driver of local economic activity. From creating jobs to generating tax revenue, the benefits of a vibrant real estate market extend beyond the investors themselves. If the administration’s policies lead to a decline in real estate investment, the negative consequences could ripple through local economies, reducing job opportunities, decreasing tax revenue, and slowing economic growth.
The Biden-Harris administration's proposals to reform the tax code and address income inequality are driven by noble intentions, but the potential consequences for the real estate investment industry cannot be ignored. By targeting provisions like the 1031 exchange and increasing capital gains taxes, the administration risks undermining investor confidence, reducing market activity, and harming the broader economy. As the debate over these policies continues, it is crucial to consider not only the goals of tax reform but also the potential unintended consequences that could ripple through the real estate industry and beyond.
I'd encourage you to send a quick letter to your Representative reminding them to support the 1031 Exchange: https://1031buildsamerica.org/take-action/
Authored by Lonnie Nielson.
Lonnie has been a real estate investor for the past 35 years and is an expert in 1031 exchanges and how to use them in order to maximize your real estate portfolio.
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