Trump's Out and Biden's In—What does this mean for 1031 Exchanges?

Finally, the dust appears to have settled, the drama has ended, and the Biden regime has begun. So where are we now, and what do I think the 1031 Exchange industry can expect in the foreseeable future?

I've been writing a prediction article every year or so since about 1998—especially when we've had a Presidential regime change. I've struggled with writing this article more than any other because, frankly, I don't have a clear vision of what's going to happen next. So I'm going to start with big, broad categories, then break them down into smaller details. In the end, I'll try to tie them all together into a prediction of where the 1031 industry is going.

Let's start with the biggie: taxes. It's no secret the Biden/Harris administration has grand liberal policy plans. They have to pay for these programs somehow, and additional taxes will be a prime resource. I anticipate there will be changes to capital gains. The capital gain tax rates on stocks and bonds will almost certainly go up. Congress may simply increase the rate, or they might increase the holding period to get the most preferential rate. A transaction tax on stock and bond sales will probably be imposed, and this could slow down the day traders who are currently active pushing the stock market to daily new highs.

The next biggie, in my opinion, is immigration. At a minimum, the new administration will loosen border restrictions. It's hard to imagine they'll simply open the doors and let everyone in unchecked, but even without that, there will major additions to the U.S. workforce. These workers will come in at the bottom of the labor force, and their addition will really saturate the minimum wage end of the market.

At the same time the administration is planning a federal minimum rate hike to $15 an hour, and I expect that to happen, although I'm not sure how fast. Most employers hire as many employees as they can for the total payroll dollars they have to spend—raise the mandatory minimum pay per employee and number of employees will decline. This could happen at a time when the pool of available (minimum wage) employees is greatly expanding.

So, what happens to all these new workers? I think two things are obvious. First, the abundance of new workers will reduce the pay of the next few pay tiers above them. For example, an employer with more $15 per hour potential employees than he can ever hire may find that he can hire $15 employees to do jobs that he is currently paying $20 or $25 per hour employees to do.

Another thing that seems obvious to me is that until the economy grows enough to absorb these excess employees, they will languish on the welfare rolls. The money for these welfare programs will come either from the reduction of other government programs (not likely), or from higher taxes (more likely). Higher taxes, however, are a ball-and-chain to business growth. The administration is going to have to find a way to grow the economy fast enough to absorb all these new workers.

The new administration is talking about a lot of environmental green energy ideas. Biden has already made policy changes to the oil and gas industry that will slow down oil and gas production. Environmental updates are desirable as technology improves, but these new green energy projects will have to absorb the jobs lost by the hydrocarbon industry and help to absorb some of the excess capacity from the immigration problem discussed above.

Which brings me to real estate. The good news: we'll have to develop housing for all the new workers added to the system from a loosened immigration policy. We will need to rezone and develop land before we begin to build, and that takes time. We'll also have to retrofit current homes and buildings for solar to keep up with the environment programs. This will require laborers and help off-set the immigration problem but will probably have to be encouraged and paid for by taxpayers.

The bad news: the COVID-19 crises is a major real estate headwind and will continue to be a log-jam until it's resolved. Vaccinations are happening, but slowly. Many small businesses are operating below the minimum level they need to make a profit.

So, what does all this have to do with 1031 exchanges? Exchanges roll the gain from the sale of the old property over to the new, and at first blush their elimination would seem to be a plausible way to raise additional taxes. However, the Congressional Budget Office has done many analyses over the decades and have always concluded that eliminating real estate 1031 exchanges would actually decrease tax revenue collection rather than increase it. This is because real estate agents, lawyers and title companies wouldn't earn fees, construction companies won't make improvements to properties, and potential sellers would rather hold a property than sell it and pay a big tax. Pretty much every new President since Eisenhower has thought about doing away with it until they discover what it will actually cost them in lost tax revenue.

Obama badly wanted to revoke the code section, but then backed off when the costs became clear. Biden was an insider to those discussions, so I don't expect him to seriously push the issue.

When the stock market becomes troublesome, many stock investors shift their investments over to real estate. Right now, the stock market is at all-time highs. But all that could change in a hurry if investors believe Congressional actions would hurt the market. A capital gains rate increase and/or a transaction tax could hurt the stock market to the benefit of real estate.

When would I expect the tax reform discussions to take place? Probably a year from now in the first quarter of 2022. Right now, the Democrats have a lot on their plate with new impeachment hearings, but after that they will shift to more important parts of their agenda. Plus, there are a lot of new administration officials that will have to be confirmed. Congress will be busy for the next six months and I don't see them getting to tax reform until September or October, after the summer recess. But with the Thanksgiving and Christmas breaks, not a lot gets done in the fall, so tax reform would need to be handled in the first quarter of next year. After that, a large segment of Congress will be running for re-election in November.

All this assumes Joe Biden is still President, as there has been speculation from both sides of the aisle that for one reason or another Kamala Harris may finish his term. If, for whatever reason, Harris does takes over as President, and has a different agenda from his, this whole discussion will have to be re-written.

Throughout my life, I have often said that Congress and politics is our country's biggest spectator sport. That's probably more true now than ever. Get the butter and the popcorn. I think the next two years is going to be very interesting.

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