Will Proposed Tax Changes Inhibit the Transfer of Real Estate?
There have been a good number of tax proposals in the news that are under consideration by the Biden Administration (BA).
The question in this short Tip is to address how such proposals—and potential new laws—will impact real estate and the planning for potential transfers of real estate.
First examine some of the proposals or changes that may become law; consider the following:
1. Tax Rates:
There are many proposed tax rate changes that will impact real estate. The highest income tax rate will potentially move from a current 37% to the prior high rate of 39.6% that existed before the Tax Cuts and Jobs Act of 2017 was passed.
Ok, maybe this small change will not have a large impact on planning; however, it is an increase; and, coupled with other changes, noted below, may prove to be important.
2. Elimination of or Reducing the benefit of 1031:
As most commercial real estate folks know, Code Section 1031, having been in the law since 1921—in one form or another—is an important rule. In summary, Code Section 1031 allows the taxpayer who qualifies under this Section, to defer the payment of income taxes on qualified gain. (For a discussion of the requirements to meet Section 1031, etc., see Levine, Mark Lee, Handbook on Exchanging Real Estate, PP & E, Amazon, etc. 2020.) The concern is that the BA has proposed to either eliminate 1031 or to reduce the deferral under the Section. (For more on the specifics of these proposed changes, see the earlier Tip by Levine as to this issue.) Before one reacts by saying that Congress has talked about such changes or elimination, but “they never do it,” consider that Congress did “do it” in the Tax Cuts and Jobs Act of 2017. It eliminated tax deferral under Code Section 1031 as to personal property. Thus, Congress could make this same type of change as to real estate. (I do not want to see this change. In addition to hurting most of us by eliminating this tool for deferral, I have 3 books in the 1031 area! Should this change take place, such books will only prove valuable for one small cookout! Of course, the books are the least of my concern. This deferral tool is an important Code Section to allow for the transfer of real estate, without paying current income tax. Code Section 1031 does require a reinvestment to qualify for the deferral.)
3. Opportunity Zones:
This area was examined in prior Tips. The reference at this point is to stress the practical point that if one enters an investment in a Qualified Opportunity Zone Fund (QOZF) under Code Section 1400Z, the investor will probably be hesitant to move or sell out of the investment in the QOZF, since such sale would cause any prior deferred gain to be recognized. Further, under the QOZF rules, the investor can gain some exclusion of potential gain earned while in the Fund, if the investor stays in the Fund for a minimum, set period. (Many readers know the rules under 1400Z allow for elimination of gain, in whole or in part, depending on the time the investor is properly in the Fund. The benefits move up as the investor hits certain holding periods of 5 years, 7 years, or 10 years+.) This means that such investors in QOZFz and their brokers, attorneys, CPAs, etc. may face delay in some transactions involving those investors possibly coming out of an investment in a QOZF.
4. Estate Tax, Basis Rules and Related Concerns:
Prior Tips have covered the following basic rules:
A. The BA has proposed to raise the Estate Tax rate to 45% or a greater number.
B. The BA has proposed to reduce the exemption that help avoid estate tax. This exemption may move from the current 11.7 million amount to 3.5 million or less. If such exemption is reduced, taxpayers must consider alternatives when dealing with their property.
C. The adjusted basis of property received from a decedent’s estate might, contrary to the law that exists at this moment, not move up to the Fair Market Value on the date of the death of the decedent. This is a proposal by the BA. In such instance, if this change applied, the beneficiary from the decedent might not want to sell or transfer the property received, if such sale would generate a large income tax to the beneficiary.
There are many more examples that could be given as to proposed BA tax changes that might inhibit a taxpayer from a disposition of their real estate.
Dr. Mark Lee Levine,
Professor, University of Denver