I’m back! It’s good to see you again. Sorry I have been out of action for a while in making videos. Fortunately, it’s largely because I’ve been a bit busy with real estate transactions. After a very slow year for retail commercial real estate in 2020, activity is definitely up in 2021. I’ve been fortunate enough to close escrow on a fully occupied strip center in Fontana, a value-add property in Hemet, and a few Sunrise Preschools properties in the Phoenix metro area.
But the reason I’m back making this video is that big news just came out a few days ago that could potentially affect real estate investors, and not in a good way. These are President Biden’s proposed changes to the tax laws.
On April 28, President Biden unveiled the American Families Plan, which would provide $1.8 trillion dollars in new spending on education, child care, and paid family leave.
Just to clarify, this is a proposal and not a law. But with Democratic majority in the House and the Senate, there is a reasonable likelihood that we could see many of these changes take effect in the very near future.
What does his plan entail?
- $400 billion dollars to expand the child tax credit so that eligible families could get payments of $3,000 to $3,600 per child
- $225 billion dollars is being allocated to subsidize child care and boost pay for child care workers.
- $225 billion for a national paid family and medical leave program
- $200 billion for free universal preschool
- $100 billion for free community college
- $45 billion for childhood and school nutrition programs
If you’ve been watching my videos, you might know that I have two young kids, so these programs sound great. But where’s the money going come from to fund these programs? I mean, the government can’t just magically print money to pay for these things. Oh wait, of course they can.
But that’s not what they’re doing in this case. They will be generating the tax dollars by making certain changes to the tax code that largely affect real estate investors and high income earners. Let’s go over the major ones. I see it as a triple whammy for high income investors. The three ways that you could be affected are:
1. Elimination of the 1031 Exchange
2. Almost doubling the tax rate on long term capital gains
3. Restricting the step up in basis rule
Let’s go over each of these.
Repealing the 1031 Exchanges for gains greater than $500,000
If you own real estate, you are likely aware of the 1031 Tax Deferred Exchange, which allows you to sell an investment property, and use the proceeds to buy another property without having to pay any tax on the profit from the first sale. This law has been around since 1921 – that’s 100 years of history! It’s been used by many investors to start small and build their wealth by trading into larger and larger properties.
Biden is proposing to eliminate the 1031 Exchange for gains greater than $500,000. If you’ve owned an investment property for a long time, then there is a good chance that your gain, if you were to sell, will be over half a million and you will lose that opportunity to roll that into a larger investment tax-free.
Taxing long term capital gains the same as ordinary income and nearly doubling the tax rate
So, you might think that you would sell the property and pay taxes on the profit. At least you would get taxed at the long term capital gains rate, which is lower than the tax rate for ordinary income. Right now, for the highest income earners, the top tax rate for capital gains is 20%. However, Biden wants to raise that to 39.6%.
Restricting the Step Up in Basis Rule
Ok, so then you think well maybe I just won’t sell this property that I’ve held for 40 years. I’ll just die and then I’ll pass it onto my kids, and THEY can get a stepped up in basis, and they can sell it tax-free.
The step up in basis rule allows the heirs of a property to reassess the cost basis of a property after the original owner dies.
But not so fast, Biden wants to eliminate that benefit for gains over $1 million dollars.
Here are a few things that we still don’t know about Biden’s plan.
- What’s the likelihood it will pass? Well, the proposal still needs to go to Congress for approval. There is a Democratic majority in Congress, however, so I’d put the odds at 50/50 or a even a little better than that some or all of these items would become law.
- When will it take effect? Generally, changes in tax laws go into effect a year or two after they are passed. However, one economist thinks that it’s possible that the laws could go into effect immediately, or even retroactively to deter tax avoidance strategies from investors, and to start collecting new tax revenues as soon as possible.
So what can you do? You can start by sending a letter to protecting to 1031 Exchange at this web site to let your representatives in Congress know that you do not support the elimination or modification of the 1031 exchange.In my opinion, these tax changes would stifle real estate investment activity by giving investors a disincentive to invest and reinvest. With less inventory, it makes it harder for new investors to get in the game, and for experienced investors to grow their wealth.
But one thing to consider is that if you are on the fence about selling your investment property, now is as good a time as any to put it on the market, before this tax proposal could become a reality.
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