The Biden Administration recently released its 2024 federal budget proposal, and once again, limits to 1031 “like-kind” exchanges are on the table. This tax provision allows taxpayers to defer capital gains taxes and depreciation recapture on the sale of business or investment properties by purchasing a like-kind replacement property, provided that the taxpayer follows a specific process and meets required deadlines.
The section titled “Repeal Deferral of Gain from Like-Kind Exchanges” outlines a proposal to limit the amount of capital gains tax deferral for like-kind property exchanges to $500,000 per individual ($1 million for married taxpayers filing jointly) per year. Capital gains in excess of this amount would be recognized by the taxpayer in the year the exchange occurs.
If passed, this law would impact exchanges that are completed after December 31, 2023.
The current budget proposal refers to 1031 exchanges as a “loophole” that “lets real estate investors defer tax indefinitely.” It suggests that closing the loophole will “ensure that the ultra-wealthy cannot use these incentives to amass tax-free fortunes.” However, there is actually much more at stake.
The 1031 exchange provision allows many middle-class taxpayers, ranchers, farmers, and business owners to exchange their currently held properties for others that better suit their needs without facing potentially crippling tax implications. Putting a cap on 1031 exchanges could leave many taxpayers with the choice of either holding onto obsolete investment properties or losing a large portion of the initial investment to capital gains taxes.
The ongoing economic effects of the COVID-19 pandemic have also created vacant space in many commercial and business properties such as hotels, office space, and retail locations. Large investors have played a critical role in repurposing and renovating these types of properties.
By doing so, they have prevented them from being abandoned and becoming a blight on their community. These types of large-scale commercial projects also create a significant number of jobs, revitalize neighborhoods, and improve the overall community. In addition, they often create significant federal, state, and local tax revenue that further strengthens the overall health of the U.S. economy.
It’s also notable that while a 1031 exchange allows taxpayers to defer their capital gains taxes, it does not eliminate them. At the time a property is sold without engaging in an exchange, the federal government receives its tax revenue.
This is not the first time the administration has set its sights on 1031 like-kind exchanges. Whether it will come to fruition this year remains to be seen.
Making the proposed change would require a revision of the tax law, which must be done through legislation passed by Congress. The current political environment may make it difficult to pass these changes, particularly since some Democrats support the current 1031 exchange rules. This potential change is also not a new threat, rather, it is a repeat of what was included in both the 2022 and 2023 budgets.
This proposal may heighten concerns for investment property owners, particularly those who are considering a sale. However, it’s helpful to keep in mind that many attempts to make changes to the 1031 exchange tax code have been made in the past. Despite these efforts, this powerful tax strategy has been relatively unchanged for over 100 years.
If you’ve been thinking about a 1031 exchange, you may wish to consider moving forward before the end of the tax year, as this may help you avoid the $500,000 limit if the proposed change is passed into law.
The team at Fortitude Investment Group continues to closely monitor this situation and will keep you informed of any developments regarding legislation or tax code changes related to 1031 exchanges. If you’re interested in exploring whether you may be able to take advantage of a 1031 exchange this year, contact us to schedule a free consultation with a member of our team.
Because investor situations and objectives vary this information is not intended to indicate suitability for any particular investor.