Joe Biden’s plan to eliminate a real estate statute to pay for improved care for children and healthcare for seniors is full of good intentions and common misconceptions.
While the COVID-19 crisis has thrust the shortcomings of government childcare and healthcare programs into public view, Dan Wagner, Senior Vice President of Government Relations for The Inland Real Estate Group of Companies, Inc., wants to emphasize that removing the tax deferment opportunity associated with 1031 exchanges isn’t the right solution to fund new initiatives.
That is because the benefits of 1031 exchanges go far beyond the buying and selling of real estate.
1031 exchanges became law nearly 100 years ago, giving real estate investors the ability to sell one property and reinvest the proceeds into a like-kind real estate investment of equal or greater value while deferring both capital gains and depreciation taxes.
“We are always trying to educate people about why 1031 exchanges have been in our tax code for so long,” Wagner said. “It is because this is not a Republican 1031 exchange or a Democrat 1031 exchange. This is a tax provision that helps all of society.”
The 1031 exchange
When an individual sells an investment property in a standard real estate transaction, that nets for example $1 million, the expected taxes will likely top $200,000, figuring 15% in capital gains along with depreciation recapture calculated at the person’s marginal tax rate.
“1031 exchange transactions generate at least 30 jobs,” said Wagner, who has 16 years of experience in real estate and has served on several real estate industry and governmental boards and committees. “You have the lender, you have the realtors, and you have the qualified intermediaries you must include every time you do a 1031. You also have the appraisers, surveyors, insurers, title companies, attorneys, and contractors.”
Without 1031 exchanges, investors would likely hold properties for longer to avoid large tax liabilities, and there could be a massive downstream impact.
“When that happens, communities will start seeing blight because people won’t be putting money into their properties like they normally do when they sell,” Wagner said. “That’s going to affect the taxes coming in to pay for fire and police departments. Without properties selling, tax assessors might have difficulty assessing property values which could negatively impact school funding.”
Not just for the rich and famous
A common misconception about real estate investors is that they are all ultra-high-net worth individuals gaming the system to avoid paying their fair share in taxes.
The reality is that there are middle-income Americans who own a duplex rental or a small apartment complex from which they’re generating income to fund a future retirement. Those individuals are then using 1031 exchanges to expand their real estate holdings over time. There are also farmers acquiring land to fund conservation projects.
The wide swath of 1031 proponents means that Wagner has company to help sound the alarm about what would happen if 1031 exchanges went away. Several national organizations, including the National Apartment Association, National Association of Realtors, Mortgage Bankers Association, Certified Commercial Investment Member Institute, Institute of Real Estate Management, and CRE Finance Council among others have representatives in Washington.
“I’m part of a real estate round table that is bringing groups together to look at different studies that have proven the benefits of 1031 exchanges to help lawmakers understand them,” Wagner said. “It’s one of those things where people forget how much work goes into real estate and how there are so many nuances.”
While Wagner is sensitive to the help children and seniors need, he also believes Biden, should he be elected, will soon recognize he must look at alternatives to eliminating the long-term benefits 1031 exchanges provide.
“All these professionals are coming together to let candidate Biden know that this is the wrong thing to do and this has major ramifications for the future of real estate,” Wagner said. “I think when they take a look and we have this discourse, I think they’ll realize that this isn’t the way to pay for something. I feel good about what 1031 exchanges have provided for the last 100 years and think they’ll be around for the next 100 years.”