The Democrat has proposed narrowing a tax code provision that allows real estate investors to avoid capital gains taxes when they sell property, as long as they use the gains to buy more. Former President Donald Trump’s most valuable investment, which traces back to his $95 million purchase of a westside Manhattan development site, has benefited from the rule.
In 2005, when Trump’s partners agreed to sell the site for $1.8 billion — a deal Trump resisted — his cut was about $500 million. Because the partners then used the capital gains from the sale to purchase two office towers — 1290 Sixth Avenue in Manhattan and 555 California Street in San Francisco — they and Trump didn’t owe any tax on their gains. Today, Trump’s stake in the buildings is worth about $1.2 billion before accounting for debt. Biden’s plan would eliminate that kind of maneuver for Trump and thousands of others with real estate investments.
The so-called 1031 like-kind exchange rule, named after a section of the tax code, was created a century ago to aid family farmers. It has evolved into a beloved tool of property moguls, Fortune 500 companies, and real estate trusts that can use it to create a daisy chain of tax avoidance.
It works like this: An investor buys a building for $4 million and sells it later for $10 million. By redeploying the proceeds into a new property within six months, she can defer paying taxes on her gains. She can repeat that process indefinitely.
When coupled with another tax break that wipes out all capital gains at death, the 1031 provision can enable real estate investors to forgo capital gains taxes entirely, enabling family dynasties to pass on riches to heirs virtually tax-free. Some wealth managers call the strategy “swap ’til you drop.”
Real estate executives say that would decrease the number of transactions, squelch economic activity and reduce property values. The National Association of Realtors argues that 1031 exchanges are crucial to keeping the commercial real estate market humming and that they’re primarily used not by the super-rich, but by less affluent retirees, investors and landlords.
Yet Internal Revenue Service data shows that more than one-third of the tax savings from 1031s goes to large institutional investors such as real estate investment trusts and corporations. The tax break is also used by the richest Americans, from the Trump and Kushner families on the East Coast, to billionaires scooping up hundreds of thousands of acres of ranch land in the American West.
Which tax bracket benefits more — the top 10% or the top 1% — is subject to debate, in part because there is no robust public database of 1031 transactions. Developers aren’t required to disclose when they take advantage of the break, and specific IRS data aren’t publicly available.
The Biden administration’s rule change would avoid hitting smaller transactions by allowing as much as $500,000 of capital gains to pass tax-free in any exchange.
Still, the proposal has stirred opposition within the real estate industry.
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