Guest Contributor: Biden Tax Plan What Happened to Section 1031?

By: Louis Rogers, founder and chief executive officer of Capital Square

By: Louis Rogers, founder and chief executive officer of Capital Square

Background.  While running for office, then Presidential hopeful, Joe Biden, and his supporters boldly stated their desire to make sweeping changes to the fabric of the nation, including tax reform. The Biden Tax Plan is an outline that describes tax reform in broad strokes.  It would make the tax code more progressive and raise substantial revenue for new programs. The starting point is to repeal President Trump’s centerpiece legislation, the Tax Cuts and Jobs Act of 2017 (TC&JA). Section 1031 of the Internal Revenue Code governing tax-deferred exchanges also would be modified.  It is important to note that the Biden Tax Plan was proposed before the COVID pandemic and is just an outline.

Biden Tax Plan.  The Biden Tax Plan would disqualify nonrecognition under Section 1031 of the Code for taxpayers with income in excess of $400,000.  Section 1031 permits the deferral of gain or loss on the sale or exchange of investment or business real estate.  It has been a part of the Code since 1921 and is widely used by real estate investors nationwide to defer taxable gains when they remain invested in real estate. Section 1031 has evolved over the years with many rules and regulations; it has become a standard part of the real estate landscape for many large and small real estate investors.

The Biden Tax Plan would make a number of other changes to the tax code:

• Increase the top tax rate from 37 percent to 39.6 percent (plus 3.8 percent surtax on net investment income) with a lower income threshold for the top rate.
• Eliminate the 20 percent pass-through deduction for anyone earning over $400,000.
• Cap the value of itemized deductions.
• Increase capital gains rates to ordinary income rates above $1 million.
• Return to pre-TC&JA estate tax rules.
• Eliminate step up in basis on death.

Also, at risk in the Biden administration are opportunity zone funds, which provide deferral and exclusion of capital gains for targeted investments in economically distressed zones.  The opportunity zone legislation was a part of President Trump’s TC&JA but had bipartisan support of Senators Tim Scott and Cory Booker.  There has been talk among Mr. Biden’s base that opportunity zone funds favor the rich and may push poor residents out of neighborhoods being gentrified.  Also, some commentators have called for greater transparency through mandatory reporting of job production and economic activity for opportunity zone funds seeking to qualify for tax benefits.

New Biden Administration.  Now, Mr. Biden has been confirmed and the COVID pandemic continues to surge across the nation.  Look for more robust stimulus spending and quickly; this is a priority for the Biden administration.

The President-elect held a press conference on January 8, 2021 to discuss current events.  He confirmed that COVID relief and economic assistance for the weakened economy are the highest priorities of his new administration.  Expect to see COVID relief legislation immediately upon taking office, including substantial payments to individuals, eviction restrictions on landlords, payments to bail out state and local governments, and other matters dealing with logistics to expedite the vaccine roll out.

Next, the new administration appears likely to push for legislation to provide economic stimulus to jumpstart the weakened economy.  This may take the form of infrastructure spending and also some facets of the “green new deal” to appease elements of the democratic base.  Expect to see substantial legislation involving trillions of dollars that will be fairly complex and take time and effort from the new administration and supporters to draft and implement.  The devil is in the details; this will consume a great deal of time and energy for the new President and his supporters.

Divided government would have created greater certainty of gridlock, but with results in from the Georgia run off, the federal government will be controlled by the President and his democratic supporters.  On paper, the democrats hold all the cards, since the Vice President has the tie breaking vote in the now evenly divided Senate and a majority in the House.  A trifecta!  But, not so fast.  The Senate is not necessarily a rubber stamp for the President and his supporters.

For example, on January 8, 2021, Senator Manchin of West Virginia was reported to say that he does not favor the $2,000 checks for individual as a part of COVID relief.  If this Senator from a relatively poor state is willing to turn down “free money” for his constituents, what can we expect when complex policy issues are presented?

On every issue, there may be one or more voices like Senator Manchin who do not support the party line.  This shows that the current democratic majority may be somewhat fragile.  It may not be so easy for the democrats to hold every vote in the Senate on complex legislation, and the House is much more divided, even more divided following the recent impeachment vote, making it much harder to pass controversial new legislation.  Matters dealing with COVID relief and economic stimulus should have an easier path than tax reform and are likely to come first.

It is too early to tell if the democratic majority will pull out all the stops and modify the filibuster rule to push legislation through the Senate with only 50 votes.  The last time the filibuster rule was modified by the democrats, the results were disastrous when the next administration took advantage of the rule change.  Cooler heads may prevail, making it difficult to change this long-standing rule that essentially requires 60 votes for most legislation to pass the Senate.

Finally, the democratic majority will have one shot at simplified congressional approval this spring as a part of the budget reconciliation process.  It is too early to tell if the democrats will use budget reconciliation for tax reform, but, based on the President-elect’s comments, COVID relief and economic stimulus are much higher priorities at the outset.

Tax Reform:  Major tax reform is much easier said than done.  This is a very complex process with many interconnected rules and regulations and requires “scoring” the tax cost by the Joint Committee on Taxation.  This is a time consuming, tedious process even when one party holds all the cards.  Because of the long lead-time to draft and score tax legislation, tax reform is likely to be a part of the agenda at a later date.  Look for tax reform later in the year at the earliest or in 2022, after and COVID relief legislation has been passed and the vaccine has been rolled out successfully on a national basis.  But a new election process will start all over again in 2022, making it more challenging next year for House members to take aggressive action heading into an election year.

Conclusion.  We are living in unprecedented times.  The democratically controlled Congress and new administration intend to make sweeping changes to the fabric of the nation during a surging COVID pandemic that is destroying large swaths of the economy.  COVID relief and economic stimulus are likely to come first, with tax reform put on the back burner until the crisis is contained.  Tax reform is not going away, just being delayed until there is sufficient time and energy.  The only thing that is certain at this stage is uncertainty; buckle up because it may be a very bumpy ride!

Louis Rogers is the founder and CEO of Capital Square, one of the leading sponsors of 1031 exchanges and other tax-advantaged real estate investment programs. A former partner at the Hirschler Fleisher law firm, he is an acknowledged expert on the legal history and application of Internal Revenue Code Section 1031.

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Opinions expressed by Rogers are his own and not necessarily reflective of those held by the editorial staff of The DI Wire.