How Biden’s real estate tax plan can hit smaller real estate investors

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Real estate investors could soon pay more taxes on high dollar transactions.

President Joe Biden calls for higher taxes on real estate transactions with profits in excess of $ 500,000. The tax plan is set to help cover the US $ 1.8 trillion family plan, which pumps money into childcare, paid family vacations, and educational programs.

However, financial experts say the tax hike could weigh on smaller investors as well.

The strategy on the chopping block – called like-kind or 1031 exchanges – allows investors to defer paying taxes on real estate by rolling profits into their next property.

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“You don’t have to haircut Uncle Sam’s portion every time you move from one investment to another,” said Michael Repak, vice president and senior estate planner at Janney Montgomery Scott in Philadelphia.

Currently, investors can use 1031 exchanges to buy and sell deferred tax real estate throughout their lives. If the investor holds the property until death, he can pass it on to the heirs tax-free.

“This was a great way for real estate investors to make money,” said Matt Berquist, certified financial planner and general manager of Intrepid Capital Management in Jacksonville, Florida.

The Joint Tax Committee of Congress estimated 1,031 exchanges could save investors $ 41.4 billion in taxes from 2020 to 2024.

Reduction in tax breaks

Biden intends to clear 1,031 exchanges for transactions of more than $ 500,000 in profit.

The impact could be far-reaching, financial experts say, particularly with calls for capital gains taxes to be increased.

According to a 2020 survey by the National Association of Realtors, about 12% of home sales were part of a 1031 exchange from 2016 to 2019.

These investors may not be the real estate tycoons that many have come to expect.

Small businesses

Although Biden’s plan targets the rich, the proposal could hit smaller investors as well.

The broker survey showed that 84% of the 1,031 exchanges were made by smaller investors – sole proprietorships (47%) or sub-companies (37%).

“There will be some unintended consequences if everything goes through,” said Berquist.

Small businesses looking to trade real estate may face tough choices.

“People have to be willing and open to make changes if necessary.”

Matt Berquist

Managing Director at Intrepid Capital Management

For example, let’s say a dental office owns a $ 1.2 million building that it originally bought for $ 500,000. Under current law, owners can swap the property for a “similar” office building and defer taxes by taking the $ 700,000 profit into a new building they bought.

The new law would impose capital gains taxes on the company’s profits above the $ 500,000 exemption.

Repak said the new rule could make it difficult for those looking for a property with less maintenance when they retire.

The proposed changes may also affect small businesses that rent properties.

Sixty-eight percent of those surveyed by brokers expect rent increases when 1,031 exchange cancellations occur.

Repak said landlords could try to offset losses or additional taxes by charging more rent.

“Tenants are probably the easiest to try,” he said.

Plan

While the details are still murky, some investors are starting to prepare for changes, according to Repak. He said it was advisable to speak to your estate planning attorney and accountant.

However, those affected should not make an impulsive decision.

“There are all sorts of things on the file that could change for people,” said Berquist. “People have to be willing and open to make changes if necessary.”

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