On April 28, President Joe Biden announced his ambitious American Families Plan, an economic agenda and massive spending package that his administration contends would improve the lives of millions of Americans. Highlights of the $1.8 trillion economic spending plan currently include child care ($225 billion), paid leave ($225 billion), universal pre-K ($200 billion), free community college ($109 billion), IRS enforcement ($700 billion), and lastly, higher taxes for the wealthiest 1% and capital gains.
Looking at that last item more closely, as part of its funding proposal, the administration targets real estate investors that are accustomed to buying and selling properties without having to pay capital gains taxes with a well-utilized rule called the 1031 tax exchange. The Plan calls for ending the right to defer certain tax payments on property-investment gains of over $500,000.
The 1031 Perk
Called a like-kind or “1031” exchange, this perk lets property investors to roll the proceeds of real estate sales into future purchases without paying capital gains taxes on profits. This deferral process can roll indefinitely until the investor’s death, and if assets are passed to an heir, the capital gains tax bill is typically wiped out. Long ago, in the 1920s, the law had its roots in trading up for farmland and farm equipment, but by 2017 Congress closed most loopholes for using this law, reserving it chiefly for real estate transactions. This is one route individuals in America have used to build substantial wealth.
This area of the Plan is most likely to hit large investors and small landlords. For real estate developers, largely those in the multifamily sector, this could change how they play their investments. Instead of going big on an apartment complex, for example, where capital gains of a sale later could mean being taxed on a million or more dollars in gains, an investor might opt for single-family homes or a duplex, where future gains might come in under that $500,000—keeping their numbers tax-exempt under the new proposed scheme.
Biden and his team have characterized this proposed Plan as an investment that would support long-term economic growth. Republicans say these hikes would harm the economy. Biden has angled for higher taxes on the wealthy as a “moral and economic imperative” for sustainable growth.
This proposal, if passed in its current framework, could also have the unintended effect of hurting the very segment it aims to help prosper: American families. If the 1031 exchange law is abolished, then single-family homes may be targeted by career developers and landlords, stiffening competition for what little inventory already exists now. Some investors will be ready to sweep inventory with cash offers, an arena in which many American families can’t possibly compete (being mortgage-reliant). Rents could also increase sharply.
With Congress being so deeply polarized, and considering it makes the laws, the Plan as it is written now is unlikely to carry through. Republican officials have already strongly pushed back on any notion of higher taxes. Any final version of the Biden proposal will likely be toned down when Congress measures the costs that this proposal includes. The President plans to host the leaders of Congress from both parties at the White House this coming week, and we’ll be watching! If you missed the initial announcement of the whole plan on April 28, you can read the White House fact sheet here.
As the economic climate resumes its momentum, Juniper Capital is here to help you finance your next real estate project. Juniper Capital provides private real estate financing, including hard money loans for commercial, construction, multi-family housing opportunities and more in the Pacific Northwest. If you would like more information on this topic, give us a call to talk to one of our experienced loan officers and start the conversation today.