May 17, 2021 | President Joe Biden is seeking higher taxes on real estate transactions with gains of more than $500,000, a target aimed directly at the heart of small real estate investors, family farmers and owner-occupied businesses. In combination with his plans to eliminate step-up basis on the resolution of estates, the Biden tax proposal will greatly increase the cost of farmland and thus food prices, property prices and rental costs in some markets.
The strategy on the political chopping block is the so-called like-kind or 1031 exchanges, which allow investors to defer paying taxes on real estate by rolling profits into their next property. Section 1031 of the Internal Revenue Code was put in place by Congress a century ago. The amount of money available for the Treasury is modest in the Biden tax proposal, but the economic damage will be vast.
The congressional Joint Committee on Taxation estimated that 1031 exchanges may save investors only $41.4 billion in taxes from 2020 to 2024, CNBC reports, but the economic benefit of 1031 exchanges to small investors and rural communities is far greater. Roughly a third of all commercial real estate transactions involved 1031 exchanges and thereby preserve important wealth that supports communities.
Why is Joe Biden declaring war on American family farmers, investors in multifamily real estate and Main Street USA? He’s not. This ill-considered proposal is the leftover agenda of former President Barack Obama, the result of a radical socialist program that stretches back nearly a century to America of the 1920s.
In his classic book “Revolt Against the Masses,” Fred Siegel describes how in the 1920s, the writers and thinkers who called themselves “liberals” -- Herbert Croly, Randolph Bourne, H.G. Wells, Sinclair Lewis and H.L Mencken -- were really authoritarians who despised successful businesses and the idea of individuals building wealth by owning property. These ideologs cared nothing for economic prosperity, only political power. The political motivation behind President Biden's attack on real estate ownership is the same today.
The modern day version of the left of the 1920s is visible in Germany today. The Biden plan for housing is a copy of the radical Green Party (former East German Communists) plans should they take power in September. Real estate transaction taxes are already double and triple in 'blue' states compared with the the level of 'red' states. And now the Greens want to attack new single-family construction by impeding zoning permits. And all of the real estate trade groups kowtow to the green political mob, which has full media support.
“The Biden Admin is making a big political mistake with this effort at social engineering using the tax code,” notes veteran mortgage executive Alan Boyce.
“Biden is declaring war on homeowners, family farms and independent businesses, many of whom invest in multifamily real estate. The combination of losing the 1031 exchange and the proposed higher Federal long-term capital gain (LTCG) tax with the higher State LTCG taxes causes a significant impact.”
Using the tax code to attack wealth that has grown in the world of real estate over the past century makes perfect sense to the far-left ideologs in the Biden Administration. Yet ironically, the Biden tax proposal will accelerate the human exodus from blue, Democratic controlled states. Both CA and NY lost congressional seats in the latest census.
Here’s some specific examples of how the Biden Administration tax proposals will hurt property owners in different states which is included in a separate spreadsheet. We look at 1031 exchanges in Coastal CA, Bakersfield, North Carolina, and Texas under current law and with the new Biden tax, for both sales and development of parcels into single-family homes.
The analysis is based upon the principle of ceterus paribus or “everything else being equal.” We infer the price that a willing seller would accept for a property after taking into account the dramatically higher state and federal taxes. Should Biden impose a mandatory tax on the gain with double LTCG taxes, here’s what happens to happens to home prices:
In expensive coastal CA, many real estate developments involve at least one 1031 (Examples 1 & 2). The state tax rate is 13.3% for all income over $500k. If you lose one exchange, land costs as a percentage of the cost of the house than doubles. Home prices need to rise by 16% for the builder in coastal CA to make the same amount of money.
In Bakersfield, CA (Example 3), the land is cheaper than in coastal communities, but the high CA state tax rate makes for big pain in terms of taxes. Also, the CA tax regime pushes up the cost of a home ~ +37%.
In the case of two 1031 exchanges in coastal California, the tax bite gets really bad. Now we have two sellers who need to raise the pre-tax price of their development ground sale to cover for the dramatic tax bite. Land as a percentage of home prices quadruples and home prices need to rise 55%.
In NC, farmsteads are often sold to developers, with grandkids taking the cash and paying the LTCG taxes (Example 4 & 5). The State tax rate is 5.5%, thus the impact of Biden’s proposed doubling of LTCG doesn’t matter if the gain is spread out over lots of grandkids. If each grandkid stays under the $500k limit for the doubled LTCG tax, then there may be no tax impact at all. Net result is home prices in the Carolinas don’t go up so much, only 4 to 10%, even with the higher LTCG.
In Texas, where there is no state tax, everything else is cheaper to do, house prices don’t go up so much. Thus, the impact is much lower than in CA. Again, the huge difference between CA and TX in terms of taxes will drive people out of coastal markets. Don’t even ask about New York.
The logic in terms of raising tax revenue behind the Biden tax proposal is also deeply suspect. “According to a study by Profs. David C. Ling and Milena Petrova, nearly 88% of exchanged properties are sold after one round, often resulting in higher paid tax amounts over time than would have otherwise been due,” notes John Harrison the Alternative & Direct Investment Securities Association in a letter to the Wall Street Journal.
“This reinvestment accelerates the velocity of money and prevents extended holding periods that lead to stagnation,” Harrison continues. “Furthermore, the study states that the repeal of section 1031 would harm tenants, property owners and the economy overall with a decrease in real-estate prices and long-term rent increases, to name a few.”
Fortunately, there are some ways about the Biden Administration’s social engineering via the tax code. For example, the landowner can contribute the land into the LLC that builds the houses as a single-family rental (SFR) avoiding recognition of capital gain.
But the really cruel joke of Joe Biden’s tax grab is on millennials, who must must give up the American Dream of owning a home. New American families face a lifetime of being renters like their counterparts in major cities in the US and Europe. Remember, the Blue Team hates homeowners, family farmers and small businesses. They want everyone to live in apartments in expensive large cities.
Joe Biden and the far-left activists who control his administration really want Americans to stop building single family homes and instead force us to live in multifamily housing that gets more units per acre. The idea of American families owning their own home flies in the face of the political agenda of the Democrats, which is all about destroying the economic base of conservatives.
If President Biden’s tax proposal is adopted, first time homebuyers will have to move to communities where the pattern of land transactions is less dependent upon 1031 exchange math and/or to lower tax states where the impact is lessened. But again, you have to wonder why Joe Biden is embracing a tax on real estate transactions that will ultimately accelerate the migration of Americans away from Democrat-controlled, high tax blue states.