If you’re like me, you just finished filing your business tax returns for 2020. As much as I hate paying taxes, I have a feeling I’m going to look back on 2020 with nostalgia. Though the pandemic delivered a terrible blow to the economy, it did come with some fantastic tax breaks. Unfortunately, I believe it will be a long time before we see a capital gains tax rate back down at 20%. However, bonus depreciation was a fantastic gimme from the Trump administration. For those not familiar, 100% first-year bonus depreciation write-offs could be carried back for up to five tax years to recover federal income taxes paid for those earlier years. This was such a fantastic write-off for real estate investors using cost segregation to accelerate depreciation on their recent purchases; it helped drive cap rates down during a recession.
OK, now I’m going to get out my crystal ball and give you my best guess at how the proposed tax hikes will cover the $3.5 trillion social policy bill. The Democrats want the top 1% of income earners to cover the cost. So they have promised not to increase taxes on families making less than $400,000 per year small businesses and family farms. It is called “tax fairness for high-income individuals.”
The individual income tax hike will most likely increase from 37% to 39.6% for those making more than $400,000 per year. Some folks are planning for this by accelerating income (consider Roth IRA conversions).
The capital gains tax rate is up for debate. It will increase from 20% but will nearly double to 39.6% on long-term capital gains in qualified dividends? Not likely, we predict that the capital gains tax rate will increase to a range between 25% – 30%.
Finally, the proposed change to section 1031 would limit the amount of gain that real estate investors would defer under a like-kind exchange if the gain exceeds $500,000 per year for a single taxpayer or $1,000,000 in the case of married individuals filing a joint return. If this passes, it will devastate the real estate investment brokerage community (not great for us). Instead of selling their assets, real estate investors might decide to pull cash out by refinancing the debt on their properties, which would likely cause a drag on real estate transactions, leading to less liquidy in the market and stifle appreciation.
Investors might look to make investments in real estate debt. It would be more appealing because lessening the 19.6% capital gains tax gap currently seen between some equity and debt investments will no longer be a factor. The Biden administration’s plan is enacted; it could be a heyday for the debt markets as more equity would flow to the space, which would be on an even playing field with equity investments.
About the author:
Todd Franks is an Executive Managing 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:
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