TAX TIPS—by Mark Lee Levine
Most business people are aware of the very expansive tax proposals that have been put forward by President Biden and his Administration. In prior Tips, we have examined some of these proposals and their implications to the same. This area is active with discussion today since the implications of the passage of such proposals are immense and very important to most taxpayers and businesses within and outside the USA.
Although no one is certain as to which of these new proposals will become law, most financial advisors, CPAs, tax attorneys, commercial real estate brokers, and others dealing with these proposals are being queried each day as to what the proposals mean, if and when they will be enacted, effective dates that apply, and many other related issues. Even without the answers to all of these questions, the search goes forward as to any indicators that are present to answer some of these queries. In light of this search for answers, many taxpayers and their advisors have waited impatiently for the release of what has been known as the “Blue Book,” or what is now known as the “Green Book” (Book). One needs to wait no longer. On 5/28/21, the Biden Administration issued its Green Book. This Book covers several important areas, such as the proposed federal spending of trillions of dollars, anticipated revenue for the Federal Government, possible borrowing for the Government that will take place, etc.
However, the key point in our Tip discussion is the information in the Green Book that addresses proposed changes as to Federal tax laws, especially those in the area of income tax, estate tax, and gift tax.
This short Tip will only highlight a few of the key areas in the Green Book that are likely to impact those involved in real estate or real estate-related areas, along with some personal income, estate, and gift-related points.
CORPORATE TAX RATE:
The first substantive area of tax discussed in the Book is the current tax rates for C (regular) corporations, the changes that have been made to the corporate rates, and what is proposed as to these rates.
In the Tax Cuts and Jobs Act of 2017, under President Trump, the corporate rate was moved from 35% on the high side to a flat rate of 21%. The much-discussed change, today, is the Biden proposal to move the rate to a flat 28%. This proposal, as in the Book, is to be effective for tax years beginning after 12/31/2021. Because it is anticipated that some corporations, to try and avoid these higher tax rates, may attempt to move their corporation to a foreign status entity, there are proposals in the Book to limit the ability of a domestic corporation to expatriate (move) their income to a foreign status. (These actions are sometimes referred to as inversion transactions.)
LOW-INCOME HOUSING CREDIT
Although we have low-income housing credits under current tax law, the amount of low-income housing in the US is, per the Biden Administration, inadequate. Thus, to encourage more low-income housing, in addition to the existing low-income housing credits, the proposal is to allow for additional housing credits, in the form of new housing credit dollars or HCDA—Housing Credit Dollar Amounts. The proposal allows for HCDA, which is also called Opportunity HCDA (OHCDA). This is to allow for more credits in this area and related to a per capita amount under the state position for the credits. How much credit would be available will be determined by a formula that will be set by the Secretary of the Treasure, working with HUD.
See the Green Book for other details to qualifying for this credit.
NEIGHBORHOOD HOMES INVESTMENT TAX CREDIT
This Biden Administration has proposed another credit labeled as the Neighborhood Homes Investment Credit (NHIC). This credit, when applicable, is to support new construction of homes, substantial rehabilitation of homes for sale, and substantial rehabilitation for existing homeowners. This is for single-family homes—up to 4 units, condos, and those residences in a housing cooperative.
The amount of the credit and how it is allocated is determined by the Secretary of the Treasury, working with HUD. This credit is to help “distressed neighborhoods,” rural communities, and certain other areas as stated within the Book.
INCREASE IN THE TOP MARGINAL INCOME TAX RATE
In the much-publicized tax rate discussion, the Book provides details of the Biden Administration proposal to increase the highest marginal income tax rate from the current 37% to 39.6%. This 39.6% rate was the highest rate that existed before it was lowered to the 37% rate under the TCJA of 2017. This proposal is effective for tax years beginning after 12/31/2021.
INCREASE IN LONG TERM CAPITAL GAIN RATES
The proposal to increase the tax rates on long-term capital gains (LTCG) has received a good deal of publicity. The proposal in the Book states:
“Tax capital income for high-income earners at ordinary rates.
Long-term capital gains and qualified dividends of taxpayers with an adjusted gross income of more than $1 million would be taxed at ordinary income tax rates, with 37 percent generally being the highest rate (40.8 percent including the net investment income tax), but only to the extent that the taxpayer’s income exceeds$1 million ($500,000 for married filing separately), indexed for inflation after 2022.”
The proposal also states, relative to LTCG and the tax rate:
“This proposal would be effective for gains required to be recognized after the date of the announcement.”
This latter quote as to the effective date has created a great stir and concern among taxpayers and their advisors. It remains to be seen, of course, whether this tax change will take place. If it does take place, there remains the additional question as to what effective date will apply.
TAX TRANSFERS OF APPRECIATED PROPERTY AT THE TIME OF A GIFT OR ON DEATH
This proposal has also generated a good deal of discussion, since such law, if passed, taxes, for income tax purposes, transactions/transfers that have not, historically, been subject to income tax. That is, the law, today, before this proposed change, will not generate an income tax, if there is a gift made during the life of the donor or if there is a bequest or devise made by a decedent to a beneficiary on the death of such property owner.
The language in the Book states:
“Under the proposal, the donor or deceased owner of an appreciated asset would realize a capital gain at the time of the transfer. For a donor, the amount of the gain realized would be the excess of the asset’s fair market value on the date of the gift over the donor’s basis in that asset. For a decedent, the amount of gain would be the excess of the asset’s fair market value on the decedent’s date of death over the decedent’s basis in that asset. That gain would be taxable income to the decedent on the Federal gift or estate tax return or on a separate capital gains return.”
Notice what is being implied is that there is no increase in the adjusted basis of a decedent at the time of death. That is, today, without any change in the tax law, the adjusted basis of assets to a beneficiary that have passed from a decedent to a beneficiary is generally the fair market value of the asset held by the decedent at the time of the death of the decedent.
Providing some relief to the taxpayer, the proposal in the Book states:
“…the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate (if any).”
What is the effective date? The Book states:
For individuals, with some qualifications, these changes apply for transfers after 12/31/2021.
There are many exceptions and qualifications to when these rules will apply and how they will apply. However, the changes are huge, moving toward taxing transactions in settings where taxpayers were not accustomed to being taxed.
LIMIT THE APPLICATION OF SECTION 1031 TAX DEFERRED EXCHANGE RULE
Code Section 1031 allows for the deferral of taxable income if a taxpayer can qualify under Code Section 1031 by exchanging real estate used in the trade or business for other qualified real estate used in a trade or business. This rule, in modified form, has been around since 1921.
However, Congress already, in 2017, repealed the application of this Section to personal property. That is, under current law, only real estate can qualify under this deferral rule.
The Biden Administration has proposed to further reduce the application of this rule by limiting the amount of gain that can be deferred. The Green Book states:
“The proposal would allow the deferral of gain up to an aggregate amount of $500,000 for each taxpayer ($1million in the case of married individuals filing a joint return) each year for real property exchanges that are like-kind. Any gains from like-kind exchanges above $500,000 (or $1million in the case of married individuals filing a joint return) during a taxable year would be recognized by the taxpayer in the year the taxpayer transfers the real property subject to the exchange.”
Thus, the exchange rule under this Section will only protect the deferral of gain up to $500,000 (1 million, if there is a married couple, filing jointly), if the taxpayer can meet the requirements of Section 1031.
This proposal, if approved, will apply for exchanges completed in tax years beginning after 12/31/2021.
OTHER PROPOSALS:
Are there other major and important tax proposals in the Book, relative to the Biden Administration’s proposals? Absolutely!
The above Tip only touches on a few of the proposals.
A few others of note include such taxing a carried profits interest as ordinary income, a new 15% minimum tax on book earnings of large corporations, making permanent the New Market Tax Credit, many changes as to tax issues related to clean energy, including issues related to fossil fuels, renewable energy, credits as to electricity transmission, credits for zero-emission vehicles, etc.
Reference should be made directly to the Green Book.
It remains to be seen what will be approved by Congress. There are many other proposals that must be kept in mind when examining the American Jobs Plan as presented by President Biden and his Administration.
By Dr. Mark Lee Levine