Over the years, real estate investors have enjoyed specific tax breaks for significant types of investments, including
the addition of larger properties and multifamily assets to their portfolios. Investors today, as well as in the past,
could defer paying taxes on property-investment gains of over half a million dollars, effectively limiting their
tax burden.
In a proposal by President Biden, the tax deferral may be abolished, resulting in a net increase in the amount of taxes faced by investors of multifamily and other types of properties. However, and it is important to note, this proposed sweeping change will directly impact only properties above the $500,000 value in capital gains.
This proposed change doesn’t just impact the original property investor. With the current tax payment deferment, known as 1031 or like-kind exchange, the investor can continue to roll the gains on real estate sale profits forward on an indefinite basis. When the original investor dies, the capital gains can often be limited through stepping up, allowing the heirs to inherit without the associated tax bill, which can be significant. However, this ability to use a step up of the cost of property is also part of the planned removal. Currently, by using the market value at the time of inheriting rather than the original purchase value (stepping up), the overall capital gains for the property are dramatically reduced for most estates. Removing the stepping up option leaves a significant tax burden for heirs of homes and other properties.
The good news is that smaller, individual investors or properties with less than $500,000 in capital gains will be protected from the proposed provision. These smaller investors, typically individuals, will continue to benefit from the current 1031 exchange rules. There are other changes included in the proposal, known as the American Families Plan. Biden has proposed a tax increase for those earning more than a million dollars from the current level of twenty percent to thirty-nine point six percent. This is a significant increase, with the additional funds earmarked for a range of different social spending initiatives from paid sick leave, health care expansion, and options for students to attend community college without tuition. While there is support for the proposed changes, it is split mainly along political lines. Some economists argue these changes may negatively impact large investors by reducing interest in the real estate market, limiting sales, and potentially leading to higher rents and property shortages on the market. Investors would have benefits in holding property longer, reducing overall liquidity in the market. If the proposal will pass and when it may come into effect is not known at this time. With the significant changes, it is unlikely to be anything that happens quickly, with options built into the legislation to protect current multifamily and other qualifying property investors who are already using the 1031 exchange deferral
