On May 28, President Biden’s green book was released containing a number of significant tax proposals that are sure to impact small business owners.
Among the proposals were changes to Section 1031 (like-kind) exchanges, a valuable tax strategy that allows a taxpayer to exchange like-kind investment properties and defer any potential gain to a later date when the exchanged for property is sold. Under the current law, there is no limit to the deferred gain amount. The current maximum capital gains rate is 20%. Plus, net investment income tax of 3.8%.
Under the President’s proposed change, the law would be altered to only allow for a deferred gain of up to $500,000 per year, or $1 million for married filing jointly taxpayers, with any gain over this threshold being taxed in the current year at an ordinary tax rate. Additionally, the President has proposed suspending the current capital gains rate, and has called for taxing capital gains at the ordinary income rate, a rate expected to increase from the current top rate of 37% to 39.6% for top earners if a Biden tax package is passed, with an additional 3.8% Net Investment Income Tax for taxpayers making over $250,000. At the top end this equates to a 43.4% tax rate.
With limits being placed on the potential deferral amount and the favorability of capital gains rates being threatened, 1031 exchanges stand to lose a good deal of their appeal under a Biden tax plan. This presents a unique opportunity for individuals to take advantage now of the beneficial Section 1031 rules before Jan. 1, 2022, the first year a potential change to the tax law would be slated to take place.