Investors Fret as Biden Takes Aim at a 100-Year-Old Tax Loophole
As a real estate investor, Michael Clarke has learned how to roll earnings from the sale of one property into the purchase of another to save on his tax bill.
Last year, Mr. Clarke sold a residential rental property that he had owned for decades in suburban Washington for $700,000 and used the proceeds to buy a $1.2 million Dollar General building in rural Virginia. Recently, he sold another long-owned rental home for $580,000 and rolled those proceeds into the purchase of a rental worth roughly $800,000.
Thanks to a 100-year-old provision in the tax code, Mr. Clarke did not have to pay taxes on the gains from the properties he sold.
Known as Section 1031, which covers a transaction that is commonly referred to as a like-kind exchange, the law provides real estate investors a tax deferral on the financial gain of a sale if they roll the proceeds directly into a similar investment property within 180 days. The rationale for the benefit is that it promotes economic activity and that, by replacing one property with another, investors are forgoing pocketing their underlying sales gains.
But the Biden administration wants to rein in Section 1031, arguing that it and other tax policies on its radar benefit the wealthy and not workers. The effort would generate $19.5 billion in tax revenue over 10 years, according to the administration’s estimates, and help pay for its $1.8 trillion proposal to help American families attain a middle-class lifestyle.
Under the Biden proposal, the deferral in any one year would be limited to gains of up to $500,000 for single taxpayers and $1 million for married taxpayers. That would effectively gut like-kind exchanges and reduce the amount of transaction activity, real estate observers contend.
“This proposal definitely concerns me,” said Mr. Clarke, who has deferred his tax bill by conducting numerous like-kind exchanges over 30 years. “It would trap capital because people won’t want to sell, and that would harm the economy.”
A large contingent of real estate interests share Mr. Clarke’s apprehension. From 2010 through 2020, like-kind exchanges accounted for 10 percent to 20 percent of all commercial real estate transactions, according to a study by David C. Ling, a real estate professor at the University of Florida, and Milena Petrova, an associate professor of real estate and finance at Syracuse University.
Not only has a flourishing niche in the real estate industry been built around like-kind exchanges, but the transactions also generate business for companies that provide insurance, title, inspection and other real estate services, supporters say. What is more, capital that is used to buy and fix up replacement assets as part of an exchange winds up in the pockets of tax collectors and laborers, they add.
Like-kind exchanges and related consumer spending could generate $7.8 billion in federal, state and local taxes in 2021, according to a study by Ernst & Young. All told, the accounting and consulting firm concluded that Section 1031 could support as many as 710,000 jobs that generate labor income of up to $34.4 billion this year.
“I find it ironic that we would constrain capital when we’re looking for ways to invest in affordable housing, to reconfigure office space and to repurpose shopping centers,” said Hessam Nadji, president and chief executive of Marcus & Millichap, a commercial real estate brokerage that has a robust like-kind exchange business. “That’s the opposite of what we should be doing coming out of a pandemic.”