CEA Legal | What Do the Proposed Changes to Section 1031 Mean for Your Real Estate Investment Strategy?

Real estate investment deserves its reputation as a lucrative source of income, but investors must always be aware of the constant changes to the laws on taxes related to real estate properties, since these rules change frequently, with the numbers and percentages changing from one year to the next. No two years are alike as far as real estate investing goes, but this year, the Biden administration has proposed major changes to sections of the Internal Revenue Code that affect real estate investing. The changes might go into effect at the beginning of 2022, and the details of the new rules have yet to be published, so it is too soon to know what strategy real estate investors should implement when they take effect. Meanwhile, if you are involved in negotiations to buy or sell a real estate property, it is in the best interest of all parties involved to conclude those sales before the end of 2021.

Next Year, the Section 1031 Tax Deferred Like-Kind Exchange Gravy Train Will End

Section 1031 of the Internal Revenue Code provides for tax deferred like-kind exchanges, in which it is possible to defer the gains from the transaction indefinitely for tax purposes. These tax deferred exchanges are a boon to real estate investors, especially small to medium-sized investors, but the proposed new code will limit the tax deferral to gains under $500,000.

The Biden administration’s proposed changes to Section 1031 aim to curtail this kind of tax deferral. The purpose of these changes is to encourage transparency in the real estate investment industry and to make it more difficult for businesses to tax advantage of loopholes in the tax code; Section 1031 is one of many sections of the tax code that the Biden administration intends to change for these reasons.

If Not Tax Deferred Exchanges, Then What?

If the tax deferred exchange strategies you currently use are not available next year, these are some other ways you can make your real estate transactions successful in 2022:

•  Tenancy in common, limited liability companies (LLCs), and condominiums may offer ways to enable the parties to the sale to remain below the $5,000 threshold.

• Qualified Opportunity Zone Funds may also present an alternative to tax deferred like-kind sales, but it is not yet clear to what extent Qualified Opportunity Zone Funds will be available in 2022.

• Section 721 exchanges (UPREIT exchanges) are currently a less attractive option than Section 1031 exchanges, but if Section 1031 exchange become unavailable next year, section 721 exchanges may be the best remaining option.

Of course, the simplest solution is just to conclude as many real estate exchanges as possible in 2021, before the Section 1031 changes go into effect. A real estate lawyer can help you complete these transactions as efficiently as possible.

Author:

• Michele Cea, Esq., Founding Member & Managing Attorney, CEA LEGAL P.C.
• Email: info@cealegal.com, Phone: (212) 618 1644

Compliments of CEA Legal P.C. – a member of the EACCNY.