New proposed tax plan seeks to eliminate 1031 exchanges

President Biden proposed Budget for FY 2024 Seeks to promote improved affordability and expanded access to healthcare and education while cutting taxes for low-income families and reducing the deficit, but the proposed money seeks to raise taxes on the wealthy and provide a significant tax break for real estate investors. comes from eliminating, which likely to be rejected outright by many in Congress.

Depending on your politics, you may have different solutions to taxes. Many might suggest that changing the tax code to be less beneficial to the wealthy is more complicated than you might think. In this case, Biden’s proposal could inadvertently harm middle-class families in the process, the research suggests.

This article takes a look at how this proposal for the tax code could specifically affect real estate investors.

raising taxes for the rich

The proposed budget would increase taxes on wealthy Americans in several ways. For example, this would be:

• Raise the capital gains tax rate from 20% to 39.6% for people earning at least $1 million in any year
• Raise the Obamacare tax rate from 3.8% to 5% for people making at least $400,000
• impose a minimum tax rate of 25% for the wealthiest 0.01%, or households with $100 million or more
• Raise the personal income tax rate from 37% to 39.6% for people making at least $400,000, reverse previous tax cuts
• Restrict maximum contributions to Roth IRA accounts for people earning at least $400,000
• Eliminates step-up based on inheritance on death affecting unrealized capital gains in excess of $5 million ($10 million for joint filers)

It is important to note that although the effective tax rate for the top 1% has decreased since the 1970s, it is still higher than eight times more That compared to the average effective tax rate for the bottom half of earners, according to the Tax Foundation. but since the federal government spent $1.38 trillion With the amount of revenue collected in 2022, it is not surprising that policymakers are considering increasing tax rates for the wealthy, especially when wealth inequality was lower in years when higher earners paid more. . research refutes the claim that cutting taxes improves the economy, and that the government collects less revenue When tax rates are low, it may be necessary to raise rates, at least for some taxpayers.

However, raising capital gains taxes above the threshold has some unintended consequences. For example, homeowners who make less than $1 million or $400,000 a year could get stuck with a tax bill. selling a house in a hot market, where a $1 million home isn’t a mansion—it’s an average-priced single-family home. For example, the average home price in San Francisco is around $1.3 million, even after the decline this past year. Even with the capital gains exclusion for primary residences, a homeowner who purchased what became a hot market 20 years ago could potentially get dinged at a higher rate the year they sell. This can make it difficult for movers to afford a similar home at today’s high mortgage rates.

It is not clear how many people would fall into this category. But it’s worth questioning whether some exceptions may be necessary and whether a capital gains tax hike is the best way to meet the federal government’s goals. For example, critics say that increasing the capital gains tax rate discourages savings, The Congressional Budget Office estimates that a tax on consumptionwhich would encourage savings on spending would have the greatest impact on reducing the deficit – but would also disproportionate impact Low income There is no easy solution.

Eliminating 1031 Exchanges

Another aspect of the proposed budget is the abolition of 1031 “Same-Kind” Exchange For real estate investors who have been around since 1921. Section 1031 of the tax code allows individuals to defer paying capital gains tax on investment property by using the proceeds from the sale to buy a similar property of equal or greater value. A fact sheet The White House compares the tax benefit to an “indefinite interest-free loan from the government” and classifies it as “wasteful spending by special interests”.

There seems to be a misconception that real estate investors are already wealthy and greedy, and that they avoid paying the proper tax rate while exploiting their tenants for higher income. Perhaps the framing of policy initiatives perpetuates conservatism, but in the vast majority of cases, it is plainly wrong. The 1031 “hole” doesn’t exclusively benefit the wealthy – it benefits real estate investors from all walks of life.

Mom-and-Pop Landlords Owned 41% of all rental properties and about 73% of all two- to four-unit buildings. These aren’t people making $1 million a year—landlords have an estimated median annual income of $97,000, While real estate is often viewed as the preferred investment vehicle for the ultra-wealthy, it is also a means for everyday people to boost their retirement savings and save enough to send their children to college. Small deals make up the majority of types of exchanges for inexpensive properties.

Ahead, research Shows there is nothing wasteful about such an exchange tax break – it plays an important role in stimulating economic activity and revitalizing communities. $97.4 billion in value to US GDP in 2021. Similar exchanges make investing more efficient, making hundreds of thousands New Job, They make it viable for investors to convert vacant commercial spaces into apartment buildings, which is important to encourage during today’s housing shortage. The National Association of Realtors offers some anecdotal example How 1031 Exchanges Have Enabled Investors to Rejuvenate Communities.

Critics say that removing 1031 exchanges will reduce federal revenue, reduce the housing shortage, and degrade housing quality for renters as property owners are forced to upgrade their units with new kitchens and bathrooms. There will be less incentive. Companies may also be discouraged from relocating to buildings that better meet the needs of the business and employees. While it’s possible that imposing limits on 1031 exchanges may have benefits, eliminating them entirely could have a significant negative impact on the economy, research suggests.

Bottom-line

There is a strong argument for raising taxes on the wealthy to finance social programs. It may not be the only way to improve economic mobility, lift people out of poverty and reduce the wealth gap, but it is a potential solution – some notable billionaire have come out in support of the idea.

But in the process of reforming the tax system, policymakers need to be careful that proposed solutions do not inadvertently harm low-income and middle-class families and communities or real estate investors who contribute to the economy in a positive way.

Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.