Back in January we began a series of posts on proposed changes to the tax code that would impact the commercial real estate market.
At first, it was our attempt to inform, but as time progressed and the likelihood of those changes became more of a possibility, we decided to take it up a notch and issue a warning that real estate values were at significant risk of decline.
We write this post to sound the alarm that danger is just ahead. This week the US Senate took the first step in pushing through a comprehensive social spending program that would cost the taxpayers at least $3.5 trillion over the next several years. The current majority party is using the ‘budget reconciliation’ process to move the legislation forward so that it can pass it with a simple majority vote in the Senate.
It is not our place to comment on the potential merits of the bill known as the American Families Plan, but it is our responsibility to you to make sure you understand how the revenue components of the plan could impact your real property investments. And, that’s what we have been doing for the last several months. As a quick review, the plan calls for capital gains to be taxed at ordinary income tax rates, limits 1031 tax-deferred exchanges to the first $500,000 in gain and would tax capital gains at death, whether or not a property is sold, effectively eliminating the widely used estate strategy known as the ‘step-up’ rule. Click here to review our previous posts.
Today we focus on the old mantra Time is of the Essence because if the American Families Plan passes as proposed, it would take effect on January 1st of 2022. That gives any investor who plans to sell or exchange in advance of the new rules just over 4 months from now to make it happen. All along we have been recommending to those who had plans to sell within the next 5 years to seek the advice of financial and tax advisors to make necessary adjustments to their investment strategies.
If you haven’t already done so, time is running short to go through the process of selling or exchanging assets in your portfolio. Loans are not funded overnight and the due diligence process can often result in delays for myriad reasons. Even the smoothest running of escrows takes at least 60 days to complete. Add lender delays and a title or environmental issue that pops up unexpectedly, and the process can easily take months longer.
We saw the sense of urgency begin to rise several months ago, and it is now accelerating every day, as there is an increasing number of California property owners out there who don’t relish the thought of paying up to 57% in state and federal taxes on their gains under the proposed law. For those looking to trade up, they are in a rush to complete their exchanges this year so that they can re-invest all their cash in their up-leg properties and not have to borrow to make up for the tax bill they would incur on the sale of their current assets.
We could go on, but our point is made. If your real estate strategy calls for a sale in the next 5 years, you are well-advised to take swift action to determine if a change in your timing is appropriate. Fortunately, demand for industrial property is through the roof and supply is severely limited. Mortgage rates are near an all-time low and long-term-minded buyers are flush with cash ready to invest.
Do we know for certain that the tax code will change? No. Do we know if there is a clear path politically to change it? Yes, and it’s looking more likely every day. The Senate is probably just a vote or two away from pushing the American Families Plan through. It only takes a simple majority vote in the House of Representatives, as well, and that body is known to vote as a block along party lines.
We ask you to ask yourself this question: If you knew the law was going to change, what action would you take?
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