How President Biden’s Tax Plan Could Impact the Real Estate Industry

With the recent swing in Senate control favoring Democrats, President-elect Joe Biden’s tax reform has become increasingly more realistic. While lawmakers may still have their hands full with coronavirus relief, Joe Biden made it clear that changes to the TCJA of 2017 will be coming – the question is, when, how significant, and how will they impact you?

Increases to the corporate gains tax rates, capital gains tax rates, and estate taxes may all be the headline grabbers, but what’s actually included in President Biden’s Tax Plan? What we know right now is that President Biden campaigned on a tax bill driven by increasing tax on high-income taxpayers (noted to be $400k and over) and providing relief to low-middle class taxpayers.   

Aside from the increases in tax rates, Biden’s proposed tax plan appears to place a heavy emphasis on reducing the tax breaks real estate developers receive. With possible changes to 1031 exchanges, opportunity zones & step-ups in basis, real estate developers and those in the industry will need to think about its impact on their current business strategy and what they can do to prepare.

Long-Term Capital Gain Rate

    • Under the proposed tax plan, the long-standing favorable capital gain tax rates, currently at a maximum rate of 20% (plus 3.8% net investment income tax), could rise to 39.6% (43.4% after the net investment income tax) for those earning over $1 million – removing the favorable treatment and essentially taxing it at ordinary rates.
      • This would result in much larger gains on a sale of a property than we have seen in the past

Like-Kind Exchanges (1031 exchanges)

    • This could be a BIG CHANGE for real estate developers, but hopefully one that will be hard to pass as many lawmakers see the economic importance of these exchanges.  A large portion of real estate development has paused due to COVID-19, so it seems lawmakers should keep items that encourage continuous development in the coming years.
    • During his campaign Biden frequently hinted towards the possible elimination of the like-kind exchange – noting that he believes this to be a loophole for property investors not to pay tax.
    • These types of exchanges have been targeted in prior tax reforms, including the limitation to real property brought by TCJA in 2017.  Note: the TCJA did remove exchanges of personal property
    • With the Senate’s tight margins, I believe this will be a heavily debated area. While Biden may see this as a loophole for property investors, the overall intent remains true – to encourage property investors to continue to re-invest.

Removal of “Step-Ups”

  • During his campaign, Biden mentioned the removal of the “step-up in basis” that revalues inherited assets to their FMV.
    • What does this mean? The beneficiary of such property would no longer receive the property at the FMV and would instead receive the property at the original cost. This could result in larger gains on appreciated property (additional tax) if the beneficiary chooses to sell such property.
    • Example:
      • Your parents bought a piece of Land in 1980 for $20,000 and held it as an investment. In 2021, the property is worth $100,000. If your parents passed and leave you as the sole beneficiary of the property, you would have a step-up in basis, and your basis in the property would be restated to $100,000. If you turn around and sell the property for $100,000, you would not be taxed on the gain as your cost basis would be equal to the sale price. If Biden’s tax reform revokes this step-up in basis, upon the passing of your parents, the property would be transferred at the original basis of $20,000. In this scenario, if the property were sold for $100,000, you would be responsible for the tax due on the $80,000 gain.

Opportunity Zones

    • Biden’s main focus is to reform, not repeal
    • Main reforms could be public disclosures and reassigning zones

Estate Taxes

    • Reduce the estate tax exemption from $11.18 million to $3.5 million (for individuals) and eliminating the step-up in basis at the taxpayer’s death, as noted above.
    • Increase top rate for the estate tax to 45%