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1031 Exchanges in the New Tax Environment
Introduction
The American real estate market provides many people with significant taxable profits on a sale. However, in the past decade, especially after President Biden came to power and announced his campaign on taxation, there has been a well-founded talk of experts that some opportunities are threatened by new possible amendments in the near future. Investors, business people in various spheres of human activity, for example, in agriculture, have the opportunity to benefit from the deferred taxation of exchange by section 1031 of the tax code during transactions for the purchase or sale of this kind of real estate. Not every law is favorable for the farmer, so any opportunities to preserve earnings, increase capital within the framework of the law are a priority (Decker & Ray, 2017). Typically, transactions can be carried out with isolated assets such as real estate, heavy equipment or works of art, but also with a line of business such as newspapers or a franchise (Ling & Petrova, 2020). However, the most common type of corporate transaction is real estate: office buildings, warehouses, parking lots and commercial buildings are similar to each other within the law, which opens up scope for the use of section 1031 for a wide range of business industries from manufacturing to retail.
Real estate must be exchanged for real estate of a similar type as a result (American Bar Association, n.d.). The most recent edits in this section were made by the Treasury Department and the IRS in 2020, including those that require filling out Form 8824 to register such an exchange (IRS, 2020). It should be noted that the case only concerns cases when transactions with real estate for the purchase or sale are made in order to support someones business or investment portfolio. As a result, taxes must be paid when the seller receives money for the property sold (American Bar Association, n.d.). This delay allows the investor or businessman to better manage the money for reinvestment in new real estate.
New Tax Environment Circumstances
Investments have various performance indicators, among which there is an indicator of profitability. This Section 1031 maximizes the legal return on real estate investments by providing investors with more excellent equity planning opportunities (American Bar Association, n.d.). Nevertheless, modern realities contain many different nuances that complicate large companies, investors, and business owners. Bidens tax policy can be described as raising and regulating taxes for huge and successful businesses (Hansen, 2021). His plans include a likely increase in corporate tax, and, among other things, the abolition of the equivalent exchange outlined in section 1031 (Hansen, 2021) is envisaged. These facts show the direction of the policy to increase government revenues at the expense of the largest companies, which have already begun to resist significantly.
Naturally, if this opportunity is canceled, investors are expected to have negative consequences in the form of paying for the property at the time of sale. Under such a Biden policy, capital gains tax rates could rise from the lowest to 39.6% (Dennis, 2021). Investors with an income of more than $ 400 thousand are waiting for answers to questions, especially enormously, since Bidens proposals may remove the possibility of deducting losses from taxable income. In addition, the processes for improving the amortization of bonuses for commercial real estate are becoming more complicated. If now specific improvements could be transformed into benefits in the same year, then after the entry into force of the changes, it will be necessary to wait up to 39 years (Dennis, 2021). However, the current plans of the real estate exchange investor need to complete their transactions soon, without waiting for the implementation of the governments plans.
Bidens priority is health care and childcare, but funding is needed for these areas. Redirecting the Opportunity Zone and Section 1031 exchange costs to the Housing Choice Voucher program could roughly double the number of housing vouchers available to very low-income families in the United States, which is often well received by experts (Weiss, 2021). The section governing exchange, 1031, has been used by many investors since it took effect almost a century ago (Thomas, 2021). However, experts do not believe that the real estate market as such will be severely affected by this and that sales and purchasing power will decline due to these amendments. However, when combined with other factors such as a pandemic, property prices could fall significantly, hitting investors and small and medium-sized businesses hard (Thomas, 2021). Such changes will encourage investors to look for a different market from real estate, although the broad set of consequences is difficult to assess now, given that the changes will begin to take effect from 2023 to 2027.
However, the investors are in the resale of real estate; that is, the investors are also pessimistic about the consequences. Some of them consider this an opportunity for honest and long-term earnings, which improves the regions overall economy and stimulates it, not a tax loophole for the wealthy (Cadmen, 2021). At the same time, the fall in prices is planned on a short-term basis since the absence of such an opportunity will not stimulate equivalent exchanges with the sale and purchase of the real estate, from which it will remain in ownership longer. The market will slow down but will stimulate the growth of rents (Cadmen, 2021). Although Biden is not the first to violate this law, no one has introduced drastic changes for commercial property. However, people in business and investors are now wary of every news regarding property taxes. It is in their interest to track all changes and more carefully approach each transaction since the possible completion date will be on the new rules effective date, which will fundamentally change the expected benefit.
On the other hand, the experts also take a different point of view. First, the tax rate on long-term capital gains should not change, despite the talk. Secondly, if these changes are applied in the long term, a significant increase in property prices is possible (Khleif, 2021). Finally, other tax deferral programs are not seen as targets for elimination.
Conclusion
While this issue could have various implications for the US real estate market, most of which are certainly not predicted by experts, the law is nevertheless still pending and was not featured in the House and Mean Reconciliation Bill in September (Keck, 2021). This fact can be considered a good sign for investors who have already discussed many possible outcomes and problems that they may face. First, the business will lose such a powerful tool that made it possible to stay afloat during such complex situations as a pandemic. Secondly, the practice of using the opportunities of section 1031 goes back about a hundred years, which has already become an integral part of the earnings of many investors, who predict a substantial slowdown in the market and a short-term fall in prices. Finally, rental property could increase in the long term, complicate the conduct of many cases, precisely because of the lack of movement in the real estate market, which is stimulated by this section. Given the complication with amortization issues, at this stage, investors and business people with incomes above $ 400,000 are trying to complete such deals before the proposed changes can take effect, but so far, no official statements have been made on this matter. In this regard, experts recommend only a more responsible approach to the conclusion of new transactions and consider new possible risks that may be reflected in return on investment and the real estate value. Any price movements in this market are still short-term, while the laws are not discussed in detail but at the level of rumors.
References
American Bar Association. (n.d.) Exchanges Under Code Section 1031.
Cadmen, E. (2021). Biden Targets $41 Billion Tax Break for Real Estate Investors. Bloomberg Tax.
Decker, J., & Ray, R. (2017). Tax Strategies for US Farmers: Tax Reduction and Averting Risk. Revista Internacional Administracion & Finanzas, 9(1), 49-61.
Dennis, K. (2021). How Bidens Tax Proposals Could Impact Real Estate Investors. Forbes.
Hansen, S. (2021). Who Will Be The Biggest Losers From Bidens Tax Hikes? Forbes.
IRS. (2020). The Treasury Department and IRS issue final regulations regarding like-kind exchanges of real property.
Keck, L. M. (2021). Like-Kind Exchanges to Be Limited Under Bidens Tax Proposals. Forbes.
Khleif, R. (2021). How Proposed Tax Changes Could Impact Multifamily Investment Profitability. Forbes.
Ling, D. C., & Petrova, M. (2020). The Impact of Like-Kind Exchanges on Investment, Leverage, and Liquidity. Journal of Real Estate Literature, 28(1), 30-49.
Thomas B. (2021). 1031 Exchange: Deal or No Deal. Forbes.
Weiss, B. M. (2021). Opportunity Zones, 1031 Exchanges, and Universal Housing Vouchers.
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