THE END OF $0 REAL ESTATE | Major Changes Explained

What's up, grandma's guys? Here. So, a few days ago, I made a video discussing my thoughts on the new personal tax increases along with an analysis of how that would affect the stock market.

However, I purposely left out one crucial point, which has the power to completely change the landscape of real estate investing and homeownership because, honestly, it deserves its own video. And that brings us to today. In the middle of one of the most heated housing markets of all time, a new tax proposal would limit one of the most popular real estate investing strategies out there, which currently allows you to buy and sell property without paying any capital gains tax in the process.

For many people, that was the entire reason to buy real estate to begin with, but that might soon change. This new proposal aims to end that, and in the process, it might actually wind up increasing home values and making it even more difficult to find a place to live. Not to mention, a new lending program might make homeownership even more affordable for more than 2 million Americans.

So, if you thought homeownership was competitive now, just wait because it might go from wild to crazy. But before we go into that, two things. Number one, I hope you understand anytime I make a video like this, I do my best to be as unbiased, open-minded, and as neutral as possible. Even though, yes, real estate is still my largest investment, and I've been a landlord now for over 10 years.

That doesn't change the fact that we have to look at every aspect objectively because, as with anything, there are going to be pros and cons that have to be taken into consideration. And second, it helps me out tremendously if you smash the like button for the YouTube algorithm. I easily spend anywhere from 12 to 18 hours to put a video like this together and research everything so nothing is left out. So, if you appreciate it and hopefully find this video entertaining, that's it. Just a quick like and that's all I ask in return.

Alright, so first, to really understand the gravity of the situation and how these changes have the power to impact how people buy and sell real estate, we got to talk about what's known as the 1031 exchange. This is a section of the tax code that allows you to buy an investment property and then sell and exchange it for another more expensive property in the future without being taxed on any of the profit in the process.

And yeah, if that sounds incredibly confusing, don't you worry. I got you, fam. And here's an example: let's just say you go and buy a two-unit duplex for five hundred thousand dollars. Ten years later, that duplex is now worth a million dollars, and all of a sudden, you want to use that profit to go and buy a larger, more expensive two million dollar building instead.

Now ordinarily, if you were to go and sell that two-unit duplex as is, you would have to pay a capital gains tax on that five hundred thousand dollars at the profit, which means in a twenty percent tax bracket, you would have four hundred thousand dollars left over to put towards that more expensive property.

However, if you qualify for a 1031 exchange, you would be able to sell that duplex for a million dollars, not pay any capital gains tax, and roll over the entire amount to the new more expensive property, where you could start the process all over again. So now, let's say another 10 years goes by, and that 2 million building is now worth 5 million. Again, normally in a situation like this, if you were to sell it at a profit, you would have to pay a 20% capital gains tax on that 3 million worth of profit, which would be a loss of six hundred thousand dollars.

But a 1031 exchange would allow you to sell that property for five million dollars and use the entire amount to put towards the next purchase, which starts the process all over again. Now, technically, you're not avoiding tax, but instead, you're deferring it in the future to the point where, eventually, if you were to sell a 15 million dollar building that you traded up to, all of those taxes you deferred from the very beginning would be owed in one lump sum, going all the way back to that first building.

The expectation here of doing this is that by allowing you to exchange one investment property for another and deferring taxes in the process, it incentivizes you to consistently trade up to more expensive real estate. It resets the property tax basis every time you buy something new, it increases inventory on the market, the high transaction costs supplies money back into the economy through real estate agents, title companies, escrow companies, inspections, notary fees, and so on.

And it prevents people from going and buying property and then holding on to it forever until they pass away. So, without going into all the specifics and making this concept more complicated than it needs to be, essentially, real estate was a way for people to get some pretty substantial tax benefits, make money without paying any tax upfront, and long term, you could build your wealth incredibly quickly.

However, here's where we start getting into some of the downsides. Right now, the new tax proposal aims to abolish the 1031 exchange and limit the amount of money that you could defer into a new property by 500,000 dollars per transaction, where anything over that would be treated as long-term capital gains. See, here's where things get pretty interesting: as it stands right now, you could 1031 as many properties as you want with any amount as often as you would like.

And the thinking is that eventually, that final property is going to be sold and at that point, all the taxes are going to be paid. But that might not be happening as often as they want. Well, that's because there's a part two of this 1031 saga where, when you pass away and your family inherits your real estate, there's something called a stepped-up tax basis that resets the taxes that they would owe to zero at the time of passing.

Like, let's just say for example, I've accumulated 20 million dollars worth of real estate throughout my lifetime with a two million dollar investment. And then when I turn 135 years old, I pass away and my family inherits my real estate. Now, normally, if I were to sell that property during my lifetime, I would end up owing a capital gains tax on that 18 million dollars worth of profit.

But if I were to pass away and leave it to my family, their tax basis gets automatically reset to the market value of 20 million dollars. And from there, they'll only have to pay any capital gains tax on anything above that amount. And this pretty much applies to any investment whatsoever, whether it be art, collectibles, stocks, bonds, real estate, you name it. And all of that could be stepped up completely tax-free up to 23 million dollars.

However, under this new plan, the stepped-up tax bases would also be removed as a way to offset the cost of free community college for students. Right now, the stepped-up tax basis saves taxpayers about 41 billion a year, which is said to be money which could be more efficiently spent elsewhere. In addition to that, the inherited property would also immediately be taxed up front on the original tax basis, regardless of whether or not you wanted to sell.

And this would apply to anybody, whether you're passing down the next family house or the next Mona Lisa. Now, critics of this say that charging taxes up front might potentially force families to have to sell off family heirlooms, real estate, and other property that's been held in the family for generations in order to come up with the tax bill. But proponents of this say the taxes should be paid up front because technically, there's a transfer of ownership.

In 2015, a study was done, which looked at the implications of the 1031 exchange in terms of how much they impacted the market, and the results were actually pretty surprising. It was found that the 1031 exchange led to more liquidity in the markets because owners were incentivized to sell, and that helped stimulate job creation, investment, and economic growth.

Like I mentioned earlier, every single time a property is sold, about five percent of that property's value goes towards paying closing costs, like paying agents, title companies, escrow companies, inspectors, notary fees, smashing a like button, inspectors, insurance companies, and so on. And in the process, all of them end up paying ordinary income taxes on the money they make. Second, it was also found that nearly 88% of exchanged real estate was eventually disposed of in a taxable event, resulting in substantially more taxes being paid than what would have been due had the exchange not occurred.

That's because the 1031 exchange incentivizes owners to keep reinvesting back into their properties and keep trading up to more and more expensive real estate, whereas otherwise, they might just keep one property for life, do minimal repairs, and that's it. In fact, when it comes to this, it was found that taxable revenue is 19% higher than from a non-1031 exchange sale, largely because those owners spent more money on their property throughout ownership at a rate of 27 to 40 cents per square foot.

Not to mention, every single time a property is sold, the tax basis is reassessed at the new value, meaning over time property tax revenue goes up, and the more people buy and sell, the more revenue is generated. So, the fear then becomes if the 1031 exchange is capped at 500,000, what's gonna happen? One argument would say that property owners would then be less incentivized to sell, and because of that, less property tax revenue would be generated.

Property owners also might be less inclined to spend money fixing up their property because they don't need to maximize the value, and that in turn could lead to slower growth in landscaping, contracting, and so on. It could also drive up the value of less expensive real estate because investors might be more inclined to get a hundred percent return on a million dollar sale that they bought for five hundred thousand dollars than a ten percent ROI and a five and a half million dollar property they bought for five million dollars.

If that happens and investors begin favoring smaller deals while competing with average homebuyers, that could further dry up housing inventory and push prices even further into the stratosphere. So, even though there might be some immediate benefits to getting rid of the 1031 exchange and collecting about 41 billion dollars more of tax revenue over the next four years, the net benefit could actually be significantly lower than that if people refuse to sell.

That leads to lower taxes generated and fewer jobs paid out in the process, and if all of that happens, that could potentially take the real estate market from crazy to insane. Now here's the thing: I rarely take an open stance on topics like this, and for the most part, I prefer to give you the objective pros and cons of each and then let you come to your own conclusion.

But because real estate is something that I have worked full time in throughout the last 13 years and it's how I built up my entire career, here are my honest thoughts and what I think is gonna happen. First, I think we should talk about removing the stepped-up tax basis. I'm actually in favor of putting some sort of limitations on this, and I think allowing heirs to receive up to 23 million dollars completely tax-free is not exactly needed.

This just encourages investors to never sell anything throughout their lifetime, and that shouldn't have to be the basis of any investing strategy. However, taxing unrealized capital gains at the time of passing is going to put a lot of pressure on families to part with generational real estate, family heirlooms, and art just to pay for an upfront tax that would force them to pick and choose what they want to keep to be able to pay for it.

Right now, the stepped-up tax basis is intact because it would be a logistical nightmare to track down the tax basis of every single item, add it up, and then figure out and calculate how much tax is owed at the time someone passes away. Like, realistically, that would be pretty much impossible to calculate on items like art, collectibles, and stocks which have been owned for decades. So, this current stepped-up tax basis makes it all very easy to keep track of and ensures that deca-millionaire fortunes end up paying some taxes.

But I think if there's a way the entire stepped-up tax basis could be removed, then it just stays entirely the same at the time of passing, where the full tax would eventually be owed at whatever point they ended up selling it, then I would actually be all for it. This would still allow you to pass down property, but the original tax basis would never change, and eventually, when the property is sold, which is 88% of the time, the full tax would be paid with no stepped-up tax basis at all.

It would be like me going and buying that 2 million property, passing it on to family when it's worth 20 million dollars, and then whenever they decide to sell it, they would have to pay the full tax on that 18 million worth of profit. And once you consider that most wealth is squandered after three generations, chances are at some point in the future, there's going to be a pretty hefty tax bill.

To me, that just seems like a very fair middle ground considering that they're not going to force a sale, but they will collect the full amount of tax due whenever it does sell. Now, second, here are my thoughts when it comes to the 1031 exchange. I'm worried that, even though it's really easy to look at this and say that removing it would end up saving 41 billion dollars over four years, what we don't know is how much money is actually going to be left over when you account for fewer properties sold, fewer property tax increases, fewer taxes paid by real estate professionals involved in the sale, and fewer improvements made to the property over its lifetime.

That alone could reverse all the tax revenue expected to be generated by removing the 1031 in the first place, and that needs to be taken into consideration. Now, I do admit that right now it does encourage people to go and buy real estate, defer taxes indefinitely, and then die so all the taxes are wiped out. So removing the stepped-up tax basis may somewhat help with this, so no taxes are outright avoided. But I think capping the limit at 500,000 would either disincentivize people from buying more expensive real estate or realistically, owners would just decide to never sell the property and do a cash-out refinance instead, so they get all that money tax-free.

I just suppose for me, there doesn't seem like much of a benefit for getting rid of it when you consider that 88% of the time, the properties are eventually sold, and all the taxes are paid. Not to mention, a government survey found that the economy would be worse off by getting rid of it than keeping it intact. All things considered, so I say keep the 1031 exchange, but get rid of the stepped-up tax basis and allow the heirs to pay the full taxes owed whenever they decide to sell. That way, taxes won't be completely eliminated, but they can be deferred to the future and then paid in full whenever they decide to sell. Not to mention, realistically we have no idea whether or not this is actually going to pass, so it's certainly something to keep an eye on.

And lastly, here's the final story. Like I mentioned earlier, 2 million homeowners could be eligible for a new mortgage program that would save them a substantial amount of money. Now, in order to qualify, you must have a mortgage backed by Fannie Mae or Freddie Mac, you must live in it as a primary residence, and you must have an income at or below 80 percent of the median income of your area. If that's you, this new program would require lenders to reduce your mortgage payment by at least 50 dollars and a half a percent reduction to your interest rate.

Then after everything is said and done, it's estimated to save homeowners anywhere from twelve hundred to three thousand dollars a year. To me, this just seems like a good way that low-income households could get access to low interest rates, whereas otherwise they might not have known this existed or they might not have had the resources to go and refinance their house. So, if you're interested in learning more about this, I'll link to it down below in the description, and maybe that helps save you some money.

So, with that said, you guys, thank you so much for watching. I really appreciate it. As always, make sure to destroy the like button, subscribe button, and notification bell. Also, feel free to add me on Instagram. I post it pretty much daily, so if you want to be a part of it there, feel free to add me there. As my second channel, The Graham Stefan Show, I post there every single day I'm not posting here. So, if you want to see a brand-new video from me every single day, make sure to add yourself to that.

And finally, if you guys want a completely free stock worth all the way up to 50 dollars, use the link down below in the description, and Public is going to be giving you a free stock for signing up. Plus, when you deposit 100 dollars on the platform by May 7th, you're gonna have a chance to win a completely free stock of Tesla. So, you may as well go ahead and do that. Worst case, you get a free stock; in best case, you get a free stock plus a free stock of Tesla. So, use that link down below, let me know which stock you get. Thank you so much for watching, and until next time.