The Azucena Take: Proposed Tax Changes and the Investment Real Estate Market
Last week, Marcus & Millichap hosted “Tax Reform: A CRE Game Changer?” with CEO Hessam Nadji (along with Jeffery Debore of the Real Estate Roundtable and Lisa Knee of EisnerAmper) to discuss the proposed tax reforms. Specifically, which of the proposed tax changes would affect the commercial real estate market and its overall.
Right now, the most important thing to understand about the proposed changes to the tax code is that they are only being proposed. It’s important to not panic or do something irrational. President Biden can't just change the tax code by decree (did you already forget your School House Rock!). First, it needs to go through a committee in the House followed by a vote. If passed, it will repeat the process in the Senate before being signed (or Vetoed) by the President.
The time in committee is important to remember as that is when some of the proposals will be approved and rewritten. Congress will also bring in experts to share their insights to help better craft the new tax codes. In the end, a few will be approved but will also be altered to benefit most people.
For those in the investment real estate market; the following are the ones to look out for:
Increase the capital gains tax rate.
Setting a $500K cap on 1031 exchanges.
Eliminating the Step-Up Basis
Taxing Carried Over Interest as Ordinary Income
The proposed changes to the capital gains will increase for those who make more than $1M at the same rate as ordinary income. Currently, it sits at 37%, but there is a proposal to move the personal tax rate up to 39.6%.
It’s the changes to the 1031 exchange that is the most concerning to the real estate market. The proposal aims to cap it at 500K, this will inhibit investors from applying their gains in new properties. A 1031 exchange is a greatly valued strategy that allows investors to exchange their property for a better one while deferring the tax payments (thus allowing them to invest in the economy).
The money saved from a 1031 exchange is mostly used to invest in the property, raising its value and creating jobs. Despite allowing investors to defer on paying capital gains taxes, it brings in over $7.8 billion for local governments.
Absolutely do not start panic selling or buying. However, if you have investments that you wish to part ways with then now would be the best time. You want to get the most out of it now before things change while also preparing for the future.