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How Biden’s Property Tax Plan Can Affect Smaller Property Investors

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Real estate investors may soon be able to pay more tax on high-dollar transactions.

President Joe Biden is asking for higher taxes on real estate transactions with gains of more than $ 500,000. The tax plan aims to help cover the $ 1.8 trillion U.S. families plan, which pumps money into child care, paid family leave and education programs.

However, financial experts say the tax increase could also put pressure on smaller investors.

The strategy on the chopping block ̵

1; so-called similar kind or 1031 exchanges – allows investors to defer paying tax on real estate by transferring profits to their next property.

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

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

“This has been a great way for real estate investors to make money,” said Matt Berquist, a Jacksonville, Florida-based certified financial planner and CEO of Intrepid Capital Management.

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

Cutting tax cuts

The bid aims to roll 1031 exchanges into transactions with profits of more than $ 500,000.

The effects can be far-reaching, say financial experts, especially with the call for an increase in capital gains tax.

Approximately 12% of property sales were part of a 1031 exchange from 2016 to 2019, according to a 2020 survey by the National Association of Realtors.

These investors may not be the real estate agents that many expect.

Small businesses

Although Biden’s plan is aimed at the wealthy, the proposal may also affect smaller investors.

The National Association of Realtors survey showed that 84% of the 1031 stock exchanges were of smaller investors – those in sole proprietorships (47%) or S companies (37%).

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

Small businesses looking to exchange property may face some tough decisions.

“People need to be ready and open to make changes as needed.”

Matt Berquist

CEO of Intrepid Capital Management

For example, suppose a dental practice owns a $ 1.2 million building that it originally purchased for $ 500,000. Under current law, owners can exchange the property for a “similar kind” of office building and defer tax by adding $ 700,000 in profits to a new building they have purchased.

The new law would levy capital gains tax on the company’s profits over the $ 500,000 exemption.

Repak said the new rule could make it difficult for those who want to switch to a less-maintenance property when they retire.

The proposed changes may also seep down to small businesses renting property.

Eighty-eight percent of those surveyed by the National Association of Realtors expect rents to rise if 1,031 exchanges occur.

Repak said landlords can try to recover losses or extra tax by charging more rent.

“Renters are probably the easiest to try to push it on,” he said.

Start planning

While details are still dark, Repak said some investors are beginning to prepare for change. He said it is wise to start talking to your real estate attorney and accountant.

However, those affected should not make an impulsive decision.

“There are all sorts of things on the dock that can change for people,” Berquist said. “People need to be ready and open to make changes as needed.”

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