Limit exchange 1031? | Finance and Trade


A proposal for President Joe Biden’s $ 1.8 trillion US Family Plan has caught the attention of concerned commercial real estate investors. It would impose a limit of $ 500,000 on 1,031 exchanges, which would allow investors to defer paying tax on real estate gains if they reinvest the proceeds to buy other property within six months of the sale.

The bill would limit earnings to $ 500,000 for each taxpayer ($ 1 million for married taxpayers filing jointly) each year for exchanges of real estate of the same nature. Any gain from exchanges of the same nature exceeding these limits would be recognized by the taxpayer in the year of the exchange. Tax relief has been part of the U.S. tax code since 1921.

Putting a limit at 1,031 exchanges “would absolutely slow the flow of capital into the industry,” said Keith Sturm, director of Minneapolis-based Upland Real Estate Group.

A proposed increase in capital gains tax from 20% to 39.6% would also reduce returns for real estate investors.

“Most commercial real estate transactions are quite large amounts, over $ 1.5 million. People don’t like paying 40 to 50 percent tax on property values. So instead of selling and losing half of their value, they could decide to keep the property, ”Sturm said.

According to a study supported by the accounting firm Ernst & Young, the elimination of 1,031 exchanges would have a negative impact on the economy of up to $ 13.1 billion per year. Analysis (supported by research from Ernst & Young) found that a repeal of 1,031 exchanges would likely result in lower federal tax revenues.

In a statement, the National Association of Realtors pointed out that 1,031 exchanges are primarily used by retirees, investors, and homeowners, not the super-rich.

To benefit from the deferral of a tax-free gain, the law also requires that before an investor closes the sale of a property intended to be used for a 1031 exchange, he enters into a contract with a qualified intermediary. who will (temporarily) receive the product sale – similar to escrow. The middleman holds the funds until the new property is purchased, said Brad Williams, a real estate attorney and partner at Dorsey & Whitney law firm in Minneapolis.

Williams said so-called “reverse swaps,” in which a replacement property is identified and purchased first, have become more common than in the past. This is driven by intense competition among buyers for suitable properties in a “hot” market.

In some cases, the tax deferral allows 1,031 home buyers to pay higher prices for more attractive properties, or to invest money in needed improvements, Williams said.

1031 swaps aren’t always relatively straightforward agreements to swap one property for another, Williams said. With new developments funded by multiple sources of capital 1031, “some of these transactions can get quite exotic.”

Bill Katter, president and chief investment officer of United Properties Development, pointed out that tax deferrals for trades of a like nature are not unique to real estate, but are also available in all other asset classes, including including the actions. Historically, trading has been heavily favored by investors to delay gains. The exchanges “have fueled the liquidity of our business, particularly for long-term net leasehold real estate; for example, a Starbucks location with a 10-year lease, ”Katter said.

Exchange 1031 has often been used by farmers who sell their land for the development of single family homes. The 1031 is generally focused on predictable income, as opposed to high-risk acquisitions, like an office building that depends on a few tenants to generate income. “Single-tenant retail and multi-family properties are good candidates for 1,031 buyers,” Katter said.

United Properties has developed a number of 7-Eleven outlets in Colorado, “and most of our buyers have sold gross properties or farmland.”

Farmers are entitled to a tax deferral on “green acres” when they sell land if it continues to be used for agriculture. Otherwise, 1,031 exchanges are the only way to avoid a big tax bill on such transactions, Katter said.

What is the probability that 1031 currency gains will be capped? “There are differing opinions on this in the industry,” Katter said. “The consensus is that it is not likely to go away.” But the odds are not zero. He said real estate investors considering a 1031 exchange should stay well informed about applicable tax law discussions taking place in Washington.

Mox Gunderson, senior director of capital markets at Jones Lang Lasalle’s Minneapolis office, said he had recently observed “an increase in speed” in 1,031 transactions, possibly attributable to a possible change in law. About half of the transactions his office handles as an intermediary broker are 1,031 exchanges, many of which are in the currently robust industrial property market. He also believes that the proposed cap is unlikely to become law, given the positive impact of the availability of 1031s on the economy.

“Any potential change in the 1031 rules is definitely a concern for sellers,” Sturm said. “If the 1031 were to disappear, it would totally change the dynamics of real estate investing.

One transaction usually triggers multiple transactions, he noted. “It can start with someone selling a building in California. That person could trade and buy a Walgreens in Minneapolis. The guy who sold this Walgreens might buy a Chick-fil-A [restaurant] in Tennessee. Eventually, someone pays the taxes, ”including national and local transfer taxes generated by each of the transactions.

Service providers involved in these transactions may include securities firms, 1031 brokerage firms, environmental firms, real estate brokers, lenders, and lawyers. All of these service providers pay income taxes for the income generated, Sturm pointed out.

The 1031 swaps also had the effect of promoting the “highest and best use” of agricultural property – for example a vacant property that is converted into multi-family housing.

The time constraints imposed on 1031 exchanges have a positive impact by prompting sellers to make decisions and complete new acquisitions on time. Without exchanges, “I would expect the speed to slow down a lot. “

Additionally, without an exchange, a certain property may not be salable, where taxes would be higher than the proceeds of a sale, Sturm said. “It often happens with farmland. “

Sturm believes the proposed cap is from people who don’t understand how the 1031 process works. “Once people understand the process and what it does [for the economy], very few people would want it eliminated.

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