It’s becoming more and more evident that the 1031 tax deferment program is on the chopping block with the current administration. I don’t want to delve into politics here but want to bring some awareness to ideas you may not be aware of as you decide how you can benefit from this amazing time in commercial real estate without paying more taxes than absolutely necessary.
As part of President Biden’s 2023 budget, the administration proposed severe limitations to so-called 1031 exchanges… While this proposal is intended to generate $1.95 billion in revenue for the government through taxing the sale of real estate, many people don’t realize that taxes paid and related to businesses using like-kind exchanges were already projected to produce $7.8 billion for the IRS last year, according to a May 2021 study by Ernst & Young.
What are the implications of Biden’s 1031 exchange limitations?
As the attached article states, if the law passes both the house and senate, the tax deferment will be limited to $500,000 for an individual or $1,000,000 for a married couple - which sounds like a lot if you are not actively engaged in commercial real estate investing. The thinking is that you must be wealthy to have a higher gain than $500,000 on a property, which also, is not necessarily the case. What people fail to realize is that to take advantage of the 1031 program, the money must go back into an investment. The investors do not get to keep and spend the money or buy other things. In addition, it must be re-invested into a like kind property with a comparable or higher sales price and debt.
Let’s dive into the part that is causing the uncertainty right now. We are hitting a time period where building owners that want to sell are having second thoughts because they fear there won’t be a property on the market for them to 1031 into. With the deadline of December 31, 2022, looming out there as the last day investors can utilize the current 1031 rules, there is concern that they will end up stuck paying taxes if they sell between now and the end of the year. This is a valid concern, but there are a few other options to consider.
What are other options to a 1031 exchange?
The first is a Delaware Statutory Trust. According to Wikipedia, “a Delaware statutory trust (DST) is a legally recognized trust that is set up for the purpose of business, but not necessarily in the U.S. state of Delaware.” The buyer is able to put their 1031-dollar amount into the purchase of a property for the equivalent percentage of ownership. This is completely mailbox money. As this type of investor, you have no decision-making authority, you just receive a check and a company manages the building for a group of investors. The good thing about this is that the buildings have already been identified and you just decide which one you want to be a part of. You work with someone that specializes in these programs and they get you plugged in.
The second option is an Intermediated Installment Sale (IIS). This defers taxes, but in a different way than the 1031. The DST still takes advantage of the 1031 laws, but is quicker due to the nature of how it works. The IIS is completely different. These programs run through the Nevada Statutory Trust program in which the trust actually buys your property and sells it to the seller you identify. You receive your purchase price in installments over twenty (20) years and basically pay taxes in the future. You put it on the market to sell, just like you would if you were doing a 1031, but during the closing process, the Nevada Statutory Trust steps in and closes on it then resells it to the original buyer.
Both of these are methods of deferring taxes and, while I’m not the expert, I can certainly put you in touch with a few that can shed a lot more light on how this would work specifically for your situation. The main point I want to share with you is that there are options and I can help you find those!
Is there still time to do a 1031 exchange before Biden’s limitations take place?
The last thing worth mentioning is that you can still buy and sell AND get it closed this year. You can always plan on doing a traditional 1031 when you put your property on the market and if you don’t identify your upleg (replacement property), you can still decide to do one of the other options before going under contract.
It’s not a time to panic, but it’s a time to be smart and know your options. We’d love to help you decide if it’s your time to sell while the market is hot, as well as, how to best position yourself after the sale. We will get together to talk about your property and bring in all the specialists we need to provide you a customized approach towards your real estate investments that best serves your interests.
Have a great June!