To increase tax revenue for the government, Joe Biden, who was running for president in 2020, said he would investigate repealing 1031 exchanges.
The Obama administration also threatened to eliminate 1031 exchanges, but no action was taken. This was not the first time that this had been promised. Section 1031 of the U.S. Internal Revenue Code remained unchanged by the recently approved Inflation Reduction Act, providing at least a short-term reprieve for 1031 exchanges.
However, the persistent focus on 1031s has dramatically increased interest in a different product, the 721 UPREIT, a real estate investment trust structured like an umbrella partnership. A unique REIT structure called a UPREIT allows investors to trade in their real estate for shares of the UPREIT. Section 721 of the Internal Revenue Code permits typically property for share swaps in a UPREIT.
But as UPREITs gain popularity, more and more DST products are beginning to release with the 721 option. The justification is reasonable. It is considerably more difficult for sponsors to raise equity from discretionary investors—those who want to invest but don’t need to—than from those who feel pressured to do so to save money on taxes.
You may have it all by attracting both types of investors by developing a 721 UPREIT-qualified product. Why not mix the two if you can amass and retain assets under control much more quickly than just doing one or the other?
The Future Of 1031 Exchanges
Returning to the subject of 1031 exchanges, there are a few reasons why it will never truly go away. First, because 1031s affect so many different professions, doing away with them would affect more than 560,000 jobs. Numerous professions depend on or are essential to the 1031 exchange process, including real estate brokers, licensed intermediates, escrow, title, appraisal, and third-party report firms. The economy would face a much worse issue if all of those individuals were made unemployed than whatever point they believe they would be resolving.
Second, the argument against 1031 exchanges is founded on the false premise that property owners will keep selling and paying taxes on the proceeds. In actuality, landowners are not required to sell anything. And astute investors are aware that they may only need to wait it out if 1031s are outlawed due to a particular presidential administration’s objective. This is because there will undoubtedly be a push to amend the laws once more and reinstate 1031 exchanges if real estate activity is hampered due to people not selling their houses.
The Future Of 721 UPREIT
However, because the political debate over removing 1031 exchanges continues, sponsors should look into other solutions to safeguard their companies. Based on the threat that the incoming Biden administration faced at the time, sponsors started to develop 721 UPREIT products, which still allow investors to postpone paying taxes on the sale of real estate but do so in a different way.