As we prepare for the next President of the United States to take office, you might be wondering how the new tax proposals from President-Elect Joe Biden could affect real estate investors. In this report, I highlight some of the proposed tax changes that would affect both real estate investors and business owners, according to the tax plan Biden released before the election.
Joe Biden has proposed to eliminate many components of the Tax and Jobs Act (TCJA) which was implemented in 2017 by President Donald Trump. The TCJA was primarily a tax reform to help stimulate the economy by reducing corporate tax rates and provide additional tax incentives to real estate investors and businesses. Now with the possible reversal of this tax reform and other proposed changes, let’s uncover the potential real estate implications.
Top 10 Changes For Real Estate Investors
#1 Elimination of bonus depreciation – a tax incentive (part of the TCJA) that allows a business or real estate investors to immediately deduct a large percentage of the purchase price of eligible assets, rather than write them off over the “useful life” of that asset. For example, real property improvements (like landscaping) have a depreciation period of 15 years and qualify for bonus depreciation. If you spend $10,000 on landscaping improvements for a rental property, you can use bonus depreciation to deduct the entire cost in the year you spend the money. Other items that may qualify for bonus depreciation include the purchase of furniture, appliances, and other real estate property improvements.
#2 Eliminate 1031 Exchanges – a 1031 exchange is a swap of one investment property for another that allows capital gains taxes to be deferred. This is a popular real estate tax strategy that has been in place since 1921 in the United States.
#3 Raise long-term capital gains tax rates for high-income earners. Long-term capital gains tax would increase for those earning over one million dollars a year (taxed at regular earned income rates rather than long-term capital gains rates). As it stands right now, the top tax bracket for long-term capital gains is 23.8% if you include the (NITT) “net investment income tax” of 3.8% which is applicable to high-income earners. Biden has proposed raising the long-term capital gains tax brackets to 43.4% for those earning over one million dollars per year.
#4 Eliminate the step-up basis. This is essentially a “death tax”. Let’s say your parents bought a house in 1970 and paid $50,000 for it, and today the house is worth $500,000. If your parents were to pass away and leave you the sole beneficiary of the house, there is a step-up basis law in place which allows the original cost basis ($50,000) to “step-up” to today’s full fair market value for tax purposes ($500,000). If you were to sell the house the next day for $500,000, there would be no tax due on the $450,000 “gain”. Under Biden’s tax proposal, this step-up basis would be eliminated, and therefore, you would be responsible for the tax due on the $450,000 “gain”.
#5 Implement a $15,000 first-time homebuyer tax credit. In 2008, the Housing and Economic Recovery Act sought to encourage Americans to purchase homes by creating a tax credit worth up to $7,500 for first-time buyers. The next year, Congress increased the amount to $8,000. The purpose was to encourage homeownership and stimulate the US housing market during The Great Recession. Biden has proposed a similar plan, but would nearly double the tax credit amount. This time, the purpose would be to allow affordability and accessibility to first-time homebuyers rather than stimulate the housing market.
#6 Phase out QBI (Qualified Business Income Deduction) for income earners making over $400,000. QBI allows eligible self-employed and small-business owners to deduct up to 20% of their qualified business income on their taxes. This could affect a large number of real estate projects and businesses.
#7 Reduce the estate tax exemption from $11.18 million to $5 million. The Tax Cuts and Jobs Act doubled the estate tax exemption to $11.18 million for individuals and $22.36 million for married couples. This means a person can pass away with $11.18 million dollars in assets and not have an estate tax due; Biden has proposed that this be reduced to 5 million dollars. This would largely affect owned assets including real estate and businesses.
#8 Raise corporate tax rates to 28% from the current 21% level. Starting in 2018, the tax law radically cut the corporate tax rate paid by C corporations from 35% to 21%. There is also a proposed 15% minimum tax for corporations with profits of $100 million or higher. This minimum tax is structured as an alternative minimum tax; corporations would pay the greater of their regular corporate income tax or the 15 percent minimum tax. Note, net operating loss (NOL) and foreign tax credits would still apply. This change would primarily affect publicly traded companies, but also some real estate businesses.
#9 Raise the top federal income tax bracket back to 39.6% from 37%. This would affect income earners who earn over $400,000 per year. Though this is not directly tied to real estate, many accredited real estate investors are high-income earners and could be affected by this change.
#10 Social Security tax increase for high income earners. As it stands today, the 12.4% Social Security tax stops kicking in once you earn more than $137,700 per year. The Biden proposal would have this tax kick back in for any income earned over $400,000. Though this is not directly tied to real estate, many accredited real estate investors are high-income earners and could be affected by this change.
To Your Success
Travis Watts and his affiliates do not provide tax, legal or accounting advice. This article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Please note that all material is subject to change and is subject to interpretation.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.