How The Proposed Tax Changes Could Impact Real Estate

On April 28, 2021, President Biden outlined new tax proposals to Congress. It was quickly made clear that there would be a notable effect on real estate investors. The most significant impact potential changes are:

• The increased top income tax rate.
• The elimination of the step-up in basis.
• The limit to 1031 tax-deferred exchanges with a capital gain greater than $500,000.

The new tax plan would increase the top income tax rate to 39.6%, up from the current 37%. In addition, the maximum tax rate on long-term capital gains would now be 43.4%, which includes the 3.8% Medicare surtax on net investment income and would apply to taxpayers with an annual income of more than $1 million. The plan would also eliminate the step-up in basis for inherited assets. Currently, when the heirs inherit a property, they benefit from a “step-up in basis” with the basis equal to the market value of the property on the day of the decedent’s death, which can significantly reduce their tax burden. Last but not least is limiting tax-deferred 1031 exchanges when the capital gain is more than $500,000. This change would have a notable impact on our industry and would completely alter the investment strategies of most real estate investors and certainly multifamily investors in particular.

Eliminating 1031 exchanges would likely reduce the number of transactions in a given market. For example, in a “hot” market like Dallas, it is customary for owners to purchase and then renovate a property and only hold it for 3-5 years before selling it and doing a 1031-exchange into a larger asset. This keeps the apartment stock in good condition and provides for the betterment of the asset and the larger community. Removing the ability to do 1031-exchange, we would likely see longer hold periods, with some owners planning to hold 20 or more years, substantially reducing the number of upgraded assets and transactions. More extended hold periods would result in less substantial property renovations (think about how a house looks after being with the same owner for 20+ years, usually dated). Multifamily values, especially properties built between 1960-1990, are predicated on the upgrades that a new owner can do to improve the income and increase the asset’s value in the quickest amount of time, with the intent to sell in a few years and do a 1031-exchange. Eliminating the 1031-exchange would likely lengthen the hold periods for these assets and reduce the amount of capital directed towards significant renovations. The ripple effect it would have on the economy wouldn’t just impact the number of transactions but also the construction industry, commodities industry, accounting, etc. The effect this would have is on Buyers and how they underwrite, which would directly impact how they make offers.

These tax changes would undoubtedly alter the investing landscape and overall economy, especially the multifamily sector.

I am happy to discuss further how the potential tax changes might impact your business and how we can help you strategize.



About the author:
Nick Brown is an Associate Director at Greystone | Investment Sales Group in Dallas, TX. If you want to learn more about our Off-Market Opportunities, Multi-Family Listings, Land Sale Listings, Property Valuations, Debt Platform, or meet for coffee to exchange value-add ideas, contact our office:

Greystone Investment Sales Group
6320 LBJ Freeway, Suite 228, Dallas, TX, 75240