What time is it?
It’s time to talk taxes and crowdfunding and to consider how we might take a concept that has been around for over 100 years and apply it to regulated investment #crowdfunding (#RIC).
First, a brief American history lesson.
The Revenue Act of 1921 authorized the first tax-deferred exchange, allowing investors to exchange securities and non-like-kind property. Over time, changes in tax legislation and interpretation by the courts limited the scope of what eventually became known as “Section 1031” of the Internal Revenue Code (IRC) to apply only to like-kind property and more specifically, real estate.
For those unfamiliar with 1031 exchanges, they are a tax-deferred exchange of like-kind property used for investment or business purposes. This type of exchange allows investors to defer paying capital gains taxes on the sale of a property by using the proceeds to purchase a similar property.
The key tenets of a 1031 exchange are:
- Only like-kind properties used for investment or business purposes can be exchanged
- The exchange must be completed within a set time frame, typically 180 days
- The exchange must be conducted through a qualified intermediary
- The proceeds from the sale of the original property must be used to purchase the replacement property in a "like-kind" exchange.
1031 exchanges are now a popular tool for real estate investors to defer capital gains tax and reinvest in new properties. However, despite the success of 1031 exchanges in real estate, the same tax benefits are not available to investors in other asset classes, including stocks and bonds.
So why not extend the same tax benefits to investors financing early stage, pre-IPO, companies? Critics might argue that the pre-IPO market is highly speculative, and that extending 1031-style tax benefits to this market could exacerbate risks for investors. However, with the passage of the JOBS Act in 2012 and the emergence of Regulated Investment Crowdfunding, there is a built-in mechanism for providing investors with some protection when they invest in a company through an SEC-approved and FINRA-regulated portal intermediary.
Therefore, it’s time for us to consider how we can leverage this concept to unlock investment gains in publicly traded equities and free them up to be redirected to smaller, pre-IPO innovators.
What are the benefits to changing the tax code to extend 1031 treatment to investment crowdfunding?
1. First, it’s good for the US Treasury. Unrealized gains on Wall Street generate no revenue for the Treasury and even when an investor’s holdings are liquidated, they may be taxed at a max capital gains rate (e.g. 20%). If moved to an emerging, revenue-producing company, then it can generate revenue for the Treasury via Corporate and personal income tax at higher rates (e. 40%) when considering combined dividend, corporate, pass-through and payroll taxes and a general increase in economic activity.
2. Second, it’s good for the REAL economy. If a BigTech company like META or Netflix sees their stock drop or increase 10%, the REAL US economy isn’t that much better or worse off. increased investment will help startups raise the capital they need to grow, hire new employees, and bring new products and services to market. The pre-IPO market is an important source high-growth startups which are a key driver of innovation, job creation, and economic growth.
3. Third, it would encourage a more diverse range of investors to participate. Currently, the pre-IPO market is dominated by a small group of wealthy individuals and institutional investors. By allowing more investors to defer their capital gains, the market will become more accessible to a wider range of individuals, including those with smaller investment portfolios.
Let’s all advocate for a change to the Internal Revenue Code (IRC) so that when an investor sells stock via a regulated exchange (e.g. NASDAQ), they have 180 days to redeploy that capital into a pre-IPO company listed on a regulated crowdfunding portal.
As this may require a legislative path to achieve success, we could call this:
The Equity Exchange and Job Creation Incentive Act
... or perhaps the:
The ReCap the American Innovators Act
Regardless of the name, it seems that the time has come to revise the IRC to make it as friendly for equity investors in earlier stage companies as it has been for real estate investors.
Interested in pursuing this kind of change? The Crowdfunding Professional Association (CfPA) is growing our membership and adding committees which focus on various issues that advance the interests of the industry. Currently, there is availability on committees which plan to tackle issues like this. Join or partner with CfPA and work with us to make these changes. s...@...m v...@...m o...@...m t...@...m
@Devin Thorpe @Jenny Kassan @Scott McIntyre @Brian Belley @Sara Hanks @Sherwood Neiss @Rebecca Kacaba
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This could be integrated with some of the tax benefits available for startup investors today under IRC Section 1202 (QSBS gains), Section 1045 (rollovers), and Section 1244 (losses).
While Section 1202 is applicable for qualified small business stock held at least 5 years (and Section 1045 rollovers for QSBS held more than 6 months but less than 5 years) - what you're proposing in allowing public-market stock into private markets is intriguing.
Some other countries give their early stage investors much more in terms of preferential tax treatment, such as the UK's EIS, SEIS, and SITR.
Thanks for the added analysis, @Brian Belley. I imagine this could be an extension of the IRC sections you reference since those already address some similar issues - but the need for an intermediary (required in 1031 exchanges) and a third party to custody funds speaks to some parallels with how crowdfunding intermediaries operate. Regardless, it would take a process to get the Internal Revenue Code (IRC) changed - a process which I'd ask @ChatGPT BOT to comment on.
To change the Internal Revenue Code (IRC), the following steps must be taken:
Legislative Proposal: A legislative proposal must be introduced in either the U.S. House of Representatives or the Senate.
Committee Review: The proposal will then be referred to the appropriate committee for review and analysis.
Public Hearing: The committee may hold a public hearing to gather input from interested parties and experts.
Markup: The committee will then markup the bill, making any necessary changes and voting on it.
Floor Vote: If the bill is approved by the committee, it will move to the floor of the House or Senate for a vote.
Conference Committee: If the bill passes in one chamber, but not the other, a conference committee may be formed to reconcile the differences between the two versions of the bill.
Presidential Approval: If the bill passes both the House and the Senate, it will be sent to the President for signature. The President can sign the bill into law or veto it.
Implementation: If the bill is signed into law, the relevant provisions of the IRC will be changed and the changes will be implemented by the Internal Revenue Service (IRS).
This process can be lengthy and requires the support of a significant number of lawmakers, as well as stakeholders and the public. Changes to the IRC can have far-reaching effects on the economy, businesses, and individuals, so it is important for the process to be well-thought-out and carefully considered.