Part 1031 Deferred inventory exchanges for tax functions

On April 28, 2021, President Biden unveiled a number of tax proposals. One of these suggestions was to restrict the use of a long-term planning tool – the Tax Deferred Like-Kind Exchange. Pursuant to Section 1031 of the Internal Revenue Code, Section 1031 exchanges are a key component of the investment real estate market, especially for small and medium-sized investors. The 1031 exchanges have long been credited with increasingly investing in real estate, increasing the pace of business in real estate, and allowing many small businesses and investors to expand and grow their respective businesses.

Following President Biden’s proposals, Section 1031 would be amended to remove the use of Section 1031 to defer profits over $ 500,000. It’s also important to know that a second Biden proposal would affect the world of 1031 exchanges as well. President Biden proposed eliminating the base elevation upon death. The result of this change would be the removal of a key benefit to the Section 1031 exchange: individual investors can essentially make the tax deferral permanent if they hold the replacement property until they die. The combined effect of these changes would dramatically reduce the profitability of 1031 exchanges for many commercial real estate transactions. A 2020 report by the National Association of Realtors found that 12% of sales transactions between 2016 and 2019 involved a similar exchange. Eliminating or reducing 1031 exchanges would lower commercial property prices as the tax deferral that enabled higher demand has been significantly undermined or even eliminated. The Federation of Exchange Accommodators identified its negative policy implications in these Article on April 28, 2021.

From a legal perspective, we will have to wait for the actual language to appear, which will affect section 1031. However, the proposed changes raise the following problems or options:

  • With a threshold of $ 500,000, more scrutiny and analysis is needed to determine which expenses are reducing profits. There has been some controversy regarding the inclusion of certain expenses versus characterizing it as a boat. That discussion will get worse as the parties try to break below the $ 500,000 mark.

  • The lease in Common, Series LLCs, and Condominiums is used as a workaround. Investors may want to break their property down into smaller pieces in order to operate a number of smaller exchanges that drop below profitability. This will make big deals even more difficult and potentially bring back many of the problems of syndication.

  • Investors may switch to other options at a slower pace, such as: B. Qualifying Opportunity Zone Funds (unless limited).

  • Investors may be driven to Section 721 (“UPREIT” Exchange) exchanges where real estate is exchanged for shares in a real estate investment trust. These are not as efficient as 1031 exchanges, but they may offer an alternative in the market.

  • Investors could come under pressure to complete the exchange in calendar year 2021.

© 2021 Davis | Kuelthau, sc All rights reservedNational Law Review, Volume XI, Number 119