We have been talking a lot about potential tax increases and their impact on commercial real estate for the last couple of months.
Our intent has been to give you an early and broad look at what is being proposed so that you can plan ahead, whether you are an investor-owner, an owner-user or a tenant looking to become an owner.
Every successful business decision starts with an idea. When investing in real estate, you gather facts, observe market trends and use your personal experience and that of other professionals to predict performance outcome. The entire process is also based on the rules of the game as they are, but also how those rules might change in the future.
So, let’s play a quick game of ‘what if’ with one of President Biden’s proposed tax hikes: elimination of the step-up rule, which allows you to pass your assets along to your heirs at a step-up in basis to fair market value on the day you die. Most of you who are reading this post have already incorporated the step-up rule into your estate plans to some degree. And, many of you are aged 55 to 75, a time when having a solid estate plan is essential.
Let’s say that you own, debt-free, the building your business occupies along with two apartment buildings you bought for passive income. The adjusted basis in all three properties adds up to $2 million, but they have a current market value of $9 million. Under current rules, if you were to die tomorrow (sorry for the morbid thought), your heirs would inherit your properties at a step-up in basis to $9 million and they could immediately sell the properties at that value and no tax would be due. Pretty good deal, right? That’s why eliminating the step-up rule is likely to be one of the tax hikes soon to be included in the infrastructure legislation that will soon be debated in Congress. It’s easier to sell to the general public than raising the gas tax, which would impact everyone.
Eliminating the step-up rule would cause your heirs to inherit the properties with your adjusted basis of $2 million. So, if they immediately sold the properties, they would pay federal capital gains taxes on the $7 million gain. That’s a world away from the current rule, and we think the possibility of it happening is worth considering.
If you are holding property assets because of the step-up rule, but the step-up rule goes away, how would that change your thinking? If your heirs will inherit your basis when you pass away anyway, why not just sell the properties now, pay your taxes and distribute the cash to your heirs while you’re still around to see them enjoy the fruits of your labor in real time? And, at least for the moment, you would pay your capital gains taxes at today’s rates, not higher rates that may also go into effect as part of Mr. Biden’s tax policy platform. We think that’s worth considering, too.
Then there is your own quality of life to consider. The old saying “you can’t take it with you” is irrefutable. It might be a good idea to think about the things you’ve always wanted to do or have, but went without because you had a business to run and a family to take care of. It’s probably safe to say that we’d all do things differently if we knew exactly when our time was up.
We are not advocating any specific course of action other than the one that you choose as best for you. Your best course of action may be to take no action at all and just keep fighting the good fight as you always have. Or, you may decide to liquidate your assets, reduce your risk and set a new direction for your life. The occasional game of ‘what if’ will open the door to alternate courses of action that may help to improve your life both quantitatively and qualitatively. Playing ‘what if’ doesn’t come at a price, but not being ready for big change will.