A look at the GOP’s 2017 tax reform plan and its potential impact on personal income, from estate and gift taxes, to capital gains exemptions.
Now that there’s a new sheriff in town (Washington DC, that is), there’s a new agenda taking shape.
A flurry of executive orders reversing previous orders and redirecting government agencies, hit in the first week of the new administration. Many of them were met with considerable resistance, and it’s way too early to tell how things will turn out.
Things are also ramping up on the legislative front, especially as it relates to healthcare and the tax code.
In this post, we take a preliminary look at the GOP’s tax reform plan and its potential impact on property ownership and valuation.
On First Look
Let us first say that we were shocked by the depth and breadth of the proposed changes. It is truly a bold plan. That is both exciting and scary at the same time. Few would argue that our spider web of a tax code doesn’t need a thorough going-over, but some of the ideas being put forward represent change at a fundamental level.
Whenever big changes occur, the benefits of those changes are likely to benefit some of us more than others.
After a cursory review of the plan’s major components, it is clear to us that the benefits will indeed be disproportionate.
Then there’s the old law of unintended consequences, which will inevitably come into play. Right now, it’s too early to say just how much will change because we don’t know how much of the plan will ever become law. It could be that nothing changes because of the polarized nature of both houses of Congress.
Assuming the plan will at least be debated vigorously, let’s take a look at just a few of the basic components, first from a personal income tax perspective and then from a corporate tax perspective.
Impact on Personal Income:
- The current 7-rate system that tops out at 39.6% would be reduced to a 3-rate format with a top bracket of 33%
- The Estate and Gift taxes would be eliminated along with the Alternative Minimum Tax (AMT)
- Itemized deductions would be limited to mortgage interest and charitable donations
- Standard dependent exemptions would increase
- The top rate for income derived from pass-through entities like Subchapter S Corporations would be 25%
- 50% of capital gains would be exempt from taxation, with the balance taxed at lower than current rates.
At first blush, these changes look pretty darn good for high income earners, small business owners who pay their business taxes at the personal level, and for those who are sitting on highly appreciated assets they hold onto because disposing of them would be too expensive. That includes many of you who are reading this post.
What’s not to like about paying less to the government and spending your money on products and services of your own choosing?
Not a thing if that’s all there was to it. But, the political optics of such a change may keep it from happening at all.
Lowering taxes for high income earners will most certainly be met with serious resistance from the progressive left, while many of those on the political right, fearful of higher deficits and runaway national debt, will be similarly resistant to lowering tax revenue without a commensurate decrease in government spending. So, the debate would likely end in a new law with a long list of exceptions and carve-outs that will simply replace one complex system for another.
That makes us wonder if uncertainty associated with tax reform will encourage a defensive investment strategy until the outcome of the tax debate becomes clear. If so, that could reduce the volume of real estate transaction activity in the short term.
If capital gains taxes are ultimately reduced, sales activity would probably increase, as the difficulty in finding exchange up-leg properties will be less of a factor. Sellers would be more inclined to cash out rather than exchange or engage in installment sales.
With more product on the market, the balance of supply and demand would shift, putting downward pressure on property values.
Adding potential changes to current Estate and Gift tax part of the tax code makes it even more interesting. Estate planners will have to start from scratch, weigh the changes and read all the fine print in order to advise high net worth individuals on how to restructure their estate plans.
Little information is available at this point, but suffice it to say that if the estate tax was eliminated, many property owners would be immediately transferring properties to heirs while they are still alive.
Currently, the law allows a transfer of up to approximately $5.4 million in assets tax-free. Without that limitation, the number of off-market property transfers would skyrocket. We are unsure what impact that would have on property values at this point, but anything that impacts transaction volume is bound to have an effect on prices.
Another interesting twist on the proposal is the different tax rates on income from pass-through entities. Those who take the bulk of their income by way of a pass-through would be taxed at 25% and not at the maximum 33% bracket on wages. If this comes to pass, expect S-Corps to get very popular very fast.
These are preliminary thoughts based on limited information. We cannot say with any certainty what changes in the GOP proposal will end up as law. The checks and balances built in to our political system are formidable, and we should all celebrate that fact. The framers of the US Constitution were very careful to give the minority a voice so that a simple majority could not wield absolute power.
To be sure, the recent election changed the balance of power between the Executive and Legislative branches of the federal government and it will take a while to see what that means in terms of real change.
We will come back to the issue of proposed changes to corporate taxation in our next post. Want us to email you when we release it? No problem, just sign up here to be notified.