We have been writing a lot about taxes in recent months because the new administration in Washington DC has proposed a number of tax hikes, several of which could send a shock wave through commercial real estate markets across the country.
President Biden’s America’s Family Plan, released on April 28, will soon be debated in both houses of Congress, and it is destined to be a spirited exercise in legislative sausage-making. It is too soon to know the outcome of those debates, and we still don’t know if the Democratically-controlled House and Senate will employ the process known as “budget reconciliation” (which would bypass a filibuster by Republicans) to finalize the legislation for President Biden’s signature. If they don’t, the whole package doesn’t have much of a chance, and you are safe for the moment.
If they do, the possibility is very real that 1031 exchange provisions for most commercial property transactions will disappear and the step-up rule, a popular estate planning tool, will go the way of the do-do bird for higher income Americans. Also included in the White House plan is to tax capital gains as ordinary income and tax those gains at death even if assets are not sold. We called it the tax trifecta a couple of months ago, and we still do today. Clearly, your reward for a successful investing career would become a monstrous penalty if one or any combination of these proposals become reality.
The fact that all this hasn’t happened yet does not mean that it won’t, which means you need to be prepared. So, this is a good time to huddle up with financial advisors you trust and get their take on what this could all mean to you based on your unique circumstances. We stand ready to help evaluate your property portfolio so that you get accurate numbers to your accountants and financial planners.
We realize this might all sound alarmist. So be it. But, we believe it is our responsibility to bring it to your attention so that you can plan accordingly. Things are moving faster and faster these days, and we would be remiss not to warn you of these potentially huge threats to the wealth you have worked so hard to attain.
On a daily basis we speak to owner/users and investors who have been contemplating a sale of their properties, but remain reluctant to take action for two main reasons:
First, they are tax-averse. After they check in with the accountant to calculate their federal and state taxes and find out that roughly a third of their gain will go to the government, they shut down the whole idea. They just can’t imagine writing checks of that magnitude to the IRS and FTB. So, they stay in the game and hope for the best. That means they are more at risk of paying over half of their gain in taxes if the Biden administration is successful in passing the American Families Plan. (Read our Tax Tail Wags Dog post from last year for more).
Second, they often tell us they are holding their properties because they don’t know what to do with the after-tax proceeds if they sell. Even though there are many ways to diversify a portfolio for further gains and mitigate risk, they stick with their current strategy and hope the property market continues to climb at its current trajectory. And, that is hard to argue with, as property values have been appreciating annually at a double-digit pace for over a decade. Looking back, a hold forever strategy was a good one. But, that was before the current threat existed and history shows us that markets run in cycles.
If you sold your property today, your net proceeds (after all taxes are paid) would be roughly the same as if you sold three years ago without paying a single penny in taxes. So, here’s a good question to ask yourself: If we had approached you with that possibility then, what would you have done?
More on this as the story unfolds. In the meantime, click this link to read the White House plan for yourself.