By Will Parker 

The Biden administration's plan to limit a longstanding property-tax break could disrupt the business of investing in apartment buildings, discouraging both amateur and professional investors who helped fuel record multifamily sales.

The tax treatment enables investors to defer capital-gains taxes if they invest profits from a real-estate sale into another property. It is used to buy and sell most types of real estate, but it has been a primary source of capital for apartment-building investors. Multifamily sales enjoyed their biggest year ever in 2019, notching more than $184 billion of properties sold.

Karlin Conklin, principal of Investors Management Group, a company that purchases and renovates aging apartment complexes, said about one-third of the capital that her firm raises for acquisitions comes from these like-kind transactions, known as 1031 exchanges. Owing capital-gains taxes could mean less investment in existing affordable housing, she said.

"I think that the industry concern is that this will very much hamper transactions, and it will also then hamper reinvestment in improvements in local economies," Ms. Conklin said.

President Biden proposed limiting the profits that investors can defer from 1031 exchanges to $500,000. U.S. investors save billions on their tax bills this way every year.

The tax deferment was created a century ago to allow investors to swap properties without being taxed as if they had pocketed cash profits. But proponents of Mr. Biden's plan say there is little reason now for real estate's privileged status in the tax code.

"Why would you treat an investment in a building differently than an investment in a stock or bond?" said Chuck Marr, senior director of federal tax policy at the left-leaning think tank the Center on Budget and Policy Priorities.

In addition to capping like-kind exchanges, Mr. Biden's plan would raise the top capital-gains tax rate to 43.4% from 23.8%.

The Biden proposal has yet to become part of a bill and passed by Congress. But property investors already view it as the latest threat to their business after the pandemic undercut many of the biggest real-estate categories. Widespread work-from-home policies have reduced office demand while travel restrictions have hurt hotel owners.

Now, commercial real-estate professionals say the proposed tax limit would cap large transactions and be a disincentive to real-estate investment. It could also reduce economic activity that is typically generated by the real-estate sector, such as employment in the construction trades hired to renovate properties, they say.

"If properties don't flip, it's going to impact other industries as well, " said Marc Wieder, co-leader of the real-estate group at the Anchin accounting firm.

Apartment buildings have been popular investments with groups of doctors, lawyers, and small-business owners who pool their funds to acquire multifamily buildings. These holdings usually provided steady income and sometimes qualified for a 1031 exchange.

But during the pandemic, many owners found the rent payments were less than reliable. Now, the Biden plan is trying to do away with the favorable tax treatment. The twin blows mean this long-popular property investment could fall out of favor with the professional class.

Melinda Fields, a Realtor from Newburyport, Mass., has used a like-kind exchange to buy a Florida investment condominium. She plans to move up to bigger investments, such as multifamily buildings, but the proposed law would discourage her from making new investments. "I would probably just keep what I have," she said.

If the tax proposal becomes law, some industry executives said, investors will have other options. Property owners would likely refinance their existing holdings instead of selling them, said Todd Pajonas, president of Legal 1031 Exchange Services Inc., a company that brokers exchanges.

Investors could then use the extra cash from refinancing to invest in more real estate, albeit in much smaller amounts than if they had been able to sell an entire property untaxed, he said.

What's more, the proposed $500,000 cap would still allow many small investors to use the tax break. Ariel Leon, a lieutenant in Stratford, Conn.'s police force, has also been a small-time landlord. Last year, looking to seize on the hot residential market, he sold his two rental houses.

After the sale, he normally would have owed a capital-gains tax of about $100,000, he said, but he did a like-kind exchange instead, investing his money tax-free into a Family Dollar store in Minnesota. That deal would still be allowed under the proposed new limit.

Write to Will Parker at will.parker@wsj.com

(END) Dow Jones Newswires

May 11, 2021 08:14 ET (12:14 GMT)