Does The Biden American Families Plan Spell Trouble For Real Estate?
Eric is a Real Estate investor, founder of MartelTurnkey, and author of Stop Trading Your Time for Money. To better understand the ramifications of this potential bill, lets take a look at the specifics. Broadly speaking, the American Families Plan is an investment in human infrastructure such as childcare and education. Thats the good part of the program. To pay for these programs, there will be increased taxes. To be clear, at this stage, the American Families Plan is just that: a plan, not yet a bill. There are still several details to be worked out. For now, though, lets focus on three specific proposed tax increases that are specifically targeting real estate and determine how this will affect our investment strategies. My view is that real estate is one of the last remaining investment opportunities the average American can use to achieve financial freedom and build a legacy for their children. Neither the stock market nor a 401(k) will do that. A family business, besides a real estate portfolio, is not as easy to transition, and often children are not interested in continuing the family business for multiple generations. So, generating a passive income through real estate investment is an ideal way to set up your childrens financial future. The first change proposed by the Biden plan would be raising the capital gains tax to 39.6% for households making over $1M dollars. Currently, the long-term capital gains tax, at its highest level, is 20%. Probably not, but it will likely discourage and/or delay property owners from selling. Property owners might opt to refinance their existing property for their next acquisitions instead, which will decrease the supply of buildings available to buy, thus driving up prices. That said, chances are anyone making over a million dollars a year will have a team of tax lawyers with strategies to avoid this sort of tax. For example, opportunity zones, endowment plans and other strategies could still be implemented to avoid paying taxes on it. Another big change in this plan: repealing the 1031 exchange for gains greater than $500,000. Above that number, you would have to pay the 39.6% capital gains tax. This tax deferment is critical for wealth building and creating multi-generational wealth. Investors who own, say, apartment buildings will likely wait to sell those properties until the capital gains or 1031 exchange laws become more favorable to them. Instead, they may pivot to smaller single-family properties to avoid the 1031 exchange. This would then reduce demand on the multi-family properties but increase demand on single-family rentals and increase their prices. This would be detrimental to middle-class Americans trying to take that first step in purchasing real estate and building long-term wealth. Also, if people simply want to buy a home to live in, home prices will also go up as investors flock to residential properties. The third major change is eliminating the stepped-up basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions) and taxing the gains if the property is not donated to charity. The reform will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business. For some reason, real estate investment is not considered a family business. Most likely, illiquid assets will be able to pay the tax over an extended period, perhaps over seven or more years. This would have a dramatic impact on multi-generational wealth. The stepped-up basis states that upon death, the value of your real estate and assets would be stepped up to their current market value. If the beneficiary of the estate decides to immediately sell, they would be paying no capital gains tax. As you can imagine, its a great way to pass on wealth to your children. Imagine that your parents owned a house in California, purchased 40 years ago at $300,000. Upon their death, the stepped-up basis now values the house at $2M (not a crazy appreciation in California, trust me). You can sell your parents house for $2M and pay no capital gains tax. Under the proposed new Biden plan, the first $1M would be exempt from the capital gains tax, but you would pay 39.6% taxes on the remaining $700,000, whether you sold the property or not. That would amount to over $277,000 in taxes to be paid upon the death of your parents, compared to nothing today. I tend to have a cynical view and assume that the very wealthy will rely on tax lawyers to shelter their assets. Their children will not have to pay taxes while still controlling the equity. Instead, the middle class, who dont have the resources for expensive tax lawyers or the time and resources to come up with new investment strategies, will end up shouldering the burden of this new plan. I also believe that the plan will impact the ability of the middle-class to invest in real estate, achieve financial freedom and leave a legacy for their children. Of course not. Investors and entrepreneurs are resourceful and always adapt. Real estate will continue to be a strong investment; it will just mark a large shift in the types of assets that are invested in. Namely, I expect residential property prices will increase as their demand goes up. I hope you found this article helpful and insightful. Forbes Real Estate Council is an invitation-only community for executives in the real estate industry.