With the election season upon us it’s a good time to review some of the tax proposals that are being suggested. According to numerous online sources, Presidential nominee Joe Biden is proposing a number of changes to the Federal tax code that would affect commercial real estate investors.
The goal of this blog post is NOT to be political or share my personal opinion BUT instead to state the facts as I understand them so that those within our industry can make thoughtful and informed decisions. And, of course, I am not a tax advisor nor an attorney and you should definitely consult such professionals before making any real estate decisions.
Please note that I relied on sources that I believe to be reputable such as Kiplinger, articles written by tax attorneys, Bloomberg, and similar. The tax proposals would include:
- The elimination of the 1031 exchange. There may be some exceptions for gains that are less than $400,000 OR when taxpayer’s income is less than $400,000 in the year of the sale – this is a bit unclear.
- The elimination of the step-up in basis upon death and/or treat the date of the owner’s death as effectively a sale with the requisite tax consequences of that sale.
- An increase in the long term capital gains rate from 20% to 39.6% for those earning more than $1M in a tax year.
- The elimination of Carried Interest’s treatment as long term capital gains. Carried interest is effectively the amount that a real estate sponsor (i.e. developer/syndicator) earns when the property they sponsored sells. For example,
- If a sponsor syndicates a $10M investment that is sold for $15M five years later, and the sponsor’s share of the gain is 30%, then the sponsor will have a gain of $1.5M.
- If treated as a long-term gain at a 20% tax rate, the sponsor would pay $300K of taxes. At 39.6%, the sponsor would pay $594,000 in taxes.
- Although one should not expect pity for the sponsor only making about $900K vs. $1.2M, but reductions in incentives do have consequences.
Keep in mind the tax proposals outlined above may not get adopted or get adopted in various forms. For example, the 1031 exchange may be eliminated, but long term capital gains may stay at 20%, and carried interest may continue using a 20% tax rate. This will have very different implications from the 1031 exchange option remaining, long term capital gains increasing to 39.6% and carried interest being eliminated.
BUT, let’s just assume that Joe Biden becomes our next President and ALL of these changes get implemented effective January 1, 2022. What might be some of the ramifications of the proposed changes: