Analyst Note| Kevin Brown |
While the Biden administration's proposed elimination of the 1031 exchange to raise tax revenue to fund the American Families Plan has caused concern among many real estate investors, we believe that the impact to U.S. REITs will be very limited. Over the past several years, REITs have disposed of tens of billions in assets each quarter and yet only rarely used a 1031 exchange to avoid capital gains taxes. If REITs pay out 90% of taxable income as dividends to shareholders, they avoid paying any corporate taxes. As a pass-through investment vehicle, the dividends paid by REITs are not considered qualified income like dividends paid by most other companies and thus are usually taxed at the highest tax bracket for each shareholder. However, part of the dividend can be reclassified as capital gains and thus taxed at a significantly lower level. Therefore, if the REIT recognizes capital gains on dispositions, the taxes owed by the shareholder on the dividend payment received from the REIT falls.