For those of you who are regular visitors to these pages, you know that we are not inclined to talk about politics. That said, we do sometimes weigh in when potential legislation that impacts commercial real estate comes up on radar. The run-up to big elections is often one of those times.
This year, the stakes are particularly high given the fact that numerous components of the Tax Cuts & Jobs Act (TCJA), otherwise known as the Trump Tax Cuts, are due to sunset at the end of 2025, some of which have been quite friendly to commercial real estate. So, whoever sits behind the Resolute Desk in the White House next January is going to be staring tax policy square in the face on day 1 of his or her presidency because the clock will be ticking loudly down to December 31, 2025.
With that in mind, in the next couple of posts we will take a partial sampling of both candidates’ proposals and discuss their likely impact on commercial property markets:
In this post we will start with the Democratic candidate who, among other things, proposes the following changes to the tax code:
- Raise the Capital Gains Tax Rate to 28% from 20% for taxpayers who earn over $1 million. The Net investment Income Tax (aka Obamacare Tax) of 3.8%, would remain, bringing the maximum capital gains tax to at least 31.8%, but some of the details of the proposal remain unclear as they were just released in the last week. This is a 40% increase in Federal Capital Gains taxes on almost all building sales, as most of the current ownership pool would realize gains well in excess of $1 million in the year of a sale.
Impact: We believe this would make a slow sales market even slower, as even at current capital gains rates, the primary reason owners don’t sell is the tax bill that goes with it. So, even if demand returned to more normal levels after the election, there won’t be much out there to buy. The net effect will be further stagnation in owner/user sales, perhaps the most important industrial property market driver in Southern California.
- Tax Unrealized Capital Gains at Death with a $5 million exemption for solo estates and $10 million for joint estates.
Impact: This element of the democratic plan would be devastating, as it would, to a large extent, neuter the benefits of the Step-Up Rule, which is probably the most widely used method of transferring wealth to heirs upon death. Currently, assets (including commercial real estate) bequeathed to heirs get a step-up in basis to market value as of the date of death. The estate of the decedent is not subject to capital gains taxes on assets that are passed to the heirs.
If enacted, this proposal would most certainly result in the immediate and ongoing sale of assets to settle the tax bill on unrealized gains rather than being passed on to heirs with a step-up in basis, as the bulk of estate value in usually concentrated in assets other than cash. The step-up rule has been around for over 100 years, originally enacted to prevent the forced sale of family farms upon the death of the family patriarch and matriarch. Though the $5 million and $10 million exemptions will protect the smaller estates from the proposed changes, it could have a massive impact on thousands of Southern California property owners who have enjoyed unprecedented price appreciation since the economy recovered from the Great Recession.
Let’s hope this never goes through, as it would drive commercial property values down short and long term. Real estate is an illiquid asset class that runs in cycles. Imagine a family forced to sell an industrial building regardless of market conditions just to pay an estate’s taxes on realized capital gains. Then add the estate taxes that may also be due if the estate is above the exemption threshold (which is set to fall by half in 2026). Not a pretty picture.
It is important to keep in mind that these proposals are only a week old and not clearly defined or understood at this point. Our research indicates that there are several interpretations in circulation. That said, if enacted in one form or another, the negative impact on the commercial real estate market would be immediate. It is also important to note that for either the Democratic or Republican proposals to move forward, the majority in both houses of Congress and the President will have to be from the same party, which is still a big unknown at this point. So, until November 5th, it’s just a guessing game, but it’s also a call to action for property owners to start thinking about how their investment strategies may need to be adjusted if these proposals become law.
Stay tuned for our next post where will take a closer look at the Republican candidate’s tax proposals and their impact on commercial real estate.
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