The real estate investment market might become less profitable if Biden takes office next year. He has proposed a plan to reduce or eliminate the 1031 exchange for individuals making over $400K/yr. The 1031 exchange allows real estate owners to reinvest revenue made from property sales into other properties without paying capital gains taxes from said revenue. Simply put, we can currently sell a property and purchase a new one with the same funds and not have to pay capital gains taxes during the exchange of investment. This plan will not sit well with real estate investors, as they will lose profits after being taxed at the highest brackets for state and federal taxes. What does this mean for the real estate economy and the individual investors within the marketplace?

When taxes increase in a market, we can see a reduction of total sales in a market, especially if the tax is too aggressive. Biden’s plan may backfire, as a dramatic increase in taxation may simply halt market sales. “You have killed your goose that lays the golden egg.” Jean-Baptiste said it best in 1896 when he observed that “The art of taxation consists in so plucking the goose as to procure the largest quantity of feathers with the least possible amount of hissing.” There are ways to optimize taxes and it can be determined experimentally– by plucking the geese. Any time a politician outlines a tax plan, they do not always intimately understand the impacts it may have on a specific market. Who is going to be plucked by Biden’s plan?

I am presently working with a retired hairdresser/teacher who is selling her house. She has owned this house for thirty years and has paid her mortgage in full. Her gains from the sale of that house are paying off the mortgage on her current home and helping her buy an investment property out of state. Without the 1031 exchange, she would be unable to buy the investment property due to lost funds from the new tax. Since she is retired and has no W2 income, it is more difficult for her to qualify for a loan than for a person with a job. The $400K limit will hurt her financially, and may keep her from a comfortable retirement. Sadly, some of the people who will suffer at the hands of this plan will not hiss loudly enough for Biden to hear.

Another aspect to consider is that with no easy tax savings, a certain percentage of properties will just be held until transfer to heirs– more so than the current rate. This stagnation of sales is the logical effect of an aggressive tax plan. There is no incentive to sell and reinvest without the 1031 intact. By eliminating the exchange, real estate transactions will reduce. Disincentivizing people to sell will negatively impact the real estate market and not provide Biden with sizable funds. While I don’t know the actual magnitude of these impacts, I believe Biden owes the public an accurate analysis of the impacts of this plan. I believe it will become clear that this attack on reinvestment is not advantageous for a stronger economy coming out of the COVID crisis.