President Joe Biden’s address earlier this week confirmed many of the plans that were being laid out in the preceding months; specifically, as they relate to real estate, capital gains and estate taxes.
Although the proposals have a long way to go before becoming law, a Democratic majority in the House and a tie-breaking vote in the Senate held by Vice President Harris creates a scenario in which the proposal will pass — provided the Democrats are able to hold their members in line.
There are three provisions which affect real estate in the Biden administration’s tax proposal.
The first, which has been talked about extensively, is the increase in the capital gains rate from 20% to 39.6%. This proposal is directed toward households making over one million dollars.
In the northeast, it doesn’t take a lot to push households to this level given residential and commercial real estate prices. This could mean an individual could pay as much as 43.4% in federal taxes alone and possibly over 50% when factoring in state taxes.
The second is the proposed elimination of the 1031 tax-free exchange when gain on a property is greater than $500,000.
This tax break allows owners of investment and business real estate to defer the gain by enabling them to purchase like-kind property within 180 days of the sale of the original property. This has been an often used technique to allow property owners to defer the entire gain on the sale of their property.
Finally, included in the tax proposal is the elimination of the “step-up“ in cost basis for inherited property.
Although we’re speaking about real estate, this applies to all property such as stocks, bonds, etc. The concept of stepping up the original cost to the fair market value at the date of the death of the owner has been in the tax law for decades, and ensured that beneficiaries who sold inherited property paid little if any capital gains tax on the immediate sale of the inherited property. This substantially reduced the tax burden for beneficiaries upon sale of the property.
Based on the likely passing of the above in some form, if you are contemplating a sale of investment or business property, careful examination should be given to the tax effect.
In prior administrations, when the capital gains rate was changed there was a cut-off date established for gains subject to the new and old rules when passed in the same year. More importantly, review your current will to ensure it is tax efficient, and consider further planning to take advantage of current estate and gift laws prior to potential changes.
Now is not the time to delay sales of property you may have been considered selling, especially real estate with a 1031 exchange.