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Big changes to the capital gains tax, including 1031 exchange, may be just around the corner, and they’re going to be an expensive blow to both real estate investors and individual homeowners. (This professionally dressed male and female are sitting at a table with laptops discussing tax changes.)

Preparing Your Family’s Financial Plans for Capital Gains Increases and the End of the 1031 Exchange

Big changes to the capital gains tax may be just around the corner, and they’re going to be an expensive blow to both real estate investors and individuals.  

President Biden’s proposed American Families Plan would expand access to childcare, education, and health care, and expand tax credits for low- and middle-income families. To pay for the $1.8 trillion plan—which includes $1 trillion in spending and $800 trillion in tax cuts—the administration plans to target capital gains taxes. 

Two elements of the president’s proposal could dramatically increase tax bills for property owners who are thinking about selling. First, the 1031 exchange—which allows real estate investors to avoid capital gains taxes on certain property sales—would be rolled back. Second, the top capital gains tax rate would be nearly doubled, from the current rate of 20 percent to a new top rate of 39.6 percent for households making more than $1 million a year. 

President Biden introduced the plan to Congress in late April. We don’t yet know anything definitive about when lawmakers will vote on the plan and how things might change before any final bills are passed. The president may have public sentiment on his side already; about three in five voters supported the American Families Plan in a Morning Consult/Politico poll completed in early May. But many American families that will be affected by higher capital gains taxes aren’t celebrating—they’re scrambling. 

Repealing the 1031 Exchange

The 1031 exchange, also called the like-kind exchange, has allowed taxpayers to defer capital gains taxes when they roll the profits of one real estate sale into the purchase of another similar property. Like-kind exchanges are projected to save real estate investors $41.4 billion in capital gains taxes between 2020 and 2024, according to data from the Joint Committee on Taxation.

Currently, if a real estate investor has an investment property they bought years ago for $200,000, and sell it for $800,000, the 1031 provision allows them to defer the capital gains tax—as long as they use the proceeds to purchase another investment property. Qualifying for a capital gains deferment under section 1031 is only possible when both properties are used for investment or business purposes. In addition, the sale of the relinquished property and the purchase of the replacement property have to be completed within 180 days.

Like-kind exchanges can be a very lucrative tax strategy for a lot of investors and can even benefit the next generation. Using a 1031 exchange makes it possible to defer capital gains taxes indefinitely. When the real estate investor dies owning the investment property, their heirs may be able to inherit any remaining property without paying capital gains taxes.

Soon, 1031 exchanges may become far less attractive for investors. If the Biden administration is able to enact its proposed changes, like-kind exchanges wouldn’t be completely eliminated—but real estate investors would no longer be able to defer capital gains taxes on gains exceeding $500,000. President Biden also wants to close the “death loophole,” which would require heirs to pay capital gains taxes on inherited property. These proposals will significantly decrease the benefits of a like-kind exchange.

Changes to the Capital Gains Tax Rates

Generally, the capital gains tax is triggered whenever a taxpayer sells a capital asset that has increased in value since they bought it. (Capital assets include real estate, cars, collectibles, stocks, and other pieces of significant property.) If you owned the asset for at least one year before selling it, any gain is taxed as a long-term capital gain. Under Biden’s proposal, if an investor’s taxable income exceeds $1,000,000, their capital gains rate could be up to 39.6%. This means that an investor who has a taxable gain of $800,000 from the sale of real property can only shield $500,000 of gain through a 1031 exchange. The remaining gain that they cannot defer may result in almost $120,000 in capital gains taxes.

Preparing for Coming Changes

The current administration’s capital gains tax plans may cause anxiety for a lot of American families. Both the rollback of 1031 exchanges and an increase in capital gains tax rates may affect your family’s long-term financial plans. 

Families that own real property for investments are now on a ticking clock. If you’ve been thinking about selling your investment property in a like-kind exchange in the near future, and expect to realize a capital gain exceeding $500,000, you may not be able to afford waiting.

The good news is, knowing that these changes might be coming means you have time to prepare. Some property owners are going to want to move up their timelines and start their real estate transactions now to take full advantage of the like-kind provision while they can. Individuals may want to sell their capital assets now to minimize their future tax bill and maximize the inheritances left to loved ones. 

The proposed increases to the capital gains tax rate may spur you to rethink your existing financial plans. It’s going to become even more important to use estate planning to preserve assets and pass them to the next generation in a tax-advantaged way. Your overall investment and tax plans may need to be adjusted to minimize any fallout from higher tax rates. It may be time to look at your real estate investments and estate plans in an entirely new way. 

Now’s the time to act. Let’s discuss how capital gains tax reform will affect you specifically, so your family doesn’t experience an expensive setback down the road. The attorneys at Sassoon Cymrot Law, LLC are here to help you prepare for whatever the future might hold. If you have questions about estate planning, tax planning or any other element of your financial plans, contact us today!

Mark Bressler concentrates his practice in commercial and residential real estate and financial services. Mr. Bressler represents businesses, real estate developers, investors and lenders in connection with their financing and development needs. He handles legal due diligence for real estate transactions including corporate structuring issues, lease review, title, survey and zoning analysis.
Scott Wittlin is a business and tax attorney with significant experience in advising businesses and the business owner. Scott works with business owners in addressing the complicated tax decisions they face in both their succession and estate planning. He works with his clients to maximize their tax benefits in all facets of their business and personal lives. He also assists families with probate and estate administration.
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