The American Families Plan & its impact on the real estate industry
TAX ALERT |
Authored by RSM US LLP
President Biden has announced The American Families Plan, representing a $1.8 trillion proposal focused on investing in increased childcare, healthcare, and education initiatives while extending many of the middle-class focused tax credits that were signed into law as part of the American Rescue Plan earlier this year. These initiatives and tax credits will primarily be funded through tax increases on high-income taxpayers as well as changes to the existing tax law. While the details of President Biden’s proposed plan are not yet available, there are several notable proposals that would be highly impactful to the Real Estate industry. The following is a brief summary of these proposals.
Tax Rates Increases
President Biden’s proposed plan would increase the maximum long-term capital gains rates from 20% to 39.6%for taxpayers making over $1 million annually. There is currently still ambiguity as to what will be includible in the $1 million threshold (gross income, adjusted gross income, taxable income, etc.). When factoring in net investment income taxes of 3.8%, the President’s proposal would increase the maximum rate paid on capital gains to a total of 43.4%.
The American Families Plan also proposes an increase to the top marginal ordinary income rate for individuals from 37% to 39.6%. This represents a reversal of the reduction in tax rate under the 2017 Tax Cuts & Jobs Act.
Further Limitations on 1031 Like-Kind Exchanges
The President’s plan also takes aim at limiting a taxpayer’s ability to utilize section 1031 Like-Kind Exchanges to defer capital gains related to sales of real property. The plan would no longer provide taxpayers the ability to utilize section 1031 Like-Kind Exchanges if the gains realized are greater than $500,000.
Repealing section 1031 Like-Kind Exchanges coupled with the proposed increase in capital gains tax rates could send ripple effects through the real estate industry, slowing the market with investors incentivized to hold existing assets for longer timeframes in the hopes of future administrations lowering the capital gains rate.
Elimination of Capital Gain Treatment for Carried Interest
The use of carried interest by hedge fund and private equity managers often times affords them the ability to pay taxes on their share of income at preferable capital gains rates. While the Tax Cuts & Jobs Act extended the holding period required for carried interests to achieve long-term capital gain treatment from one to three years, President Biden is seeking to remove the eligibility of capital gains treatment on carried interest all together. Under the President’s plan, carried interest income allocations would be taxed as ordinary income as opposed to capital gains.
At first glance, it may appear that the proposed increase to capital gains rates effectively eliminates the benefit of the carried interest provisions. However, if President Biden were successful in eliminating the capital gains treatment on carried interests, the carried interest amounts would be subject to ordinary tax rates even if the proposed increase to capital gain rates does not become law or re-negotiated down to a lower percentage as part of the lawmaking process.
Real estate investors largely escaped the changes to the carried interest rules under the Tax Cuts & Jobs Act. Section 1231 gains, such as gains recognized from the sale of a rental property, were not subject to these rules. President Biden specifically called out the hedge fund industry when discussing these proposed changes to carried interests, but it is unclear at this time whether or not he intends to re-class carried interest allocations of Section 1231 gains to be ordinary income. Recent bills, such as The Carried Interest Fairness Act, have been introduced that would make section 1231 gains subject to the carried interest provisions so it does appear that this is on the table.
Death as a Recognition Event
The proposed plan would require taxation of all unrealized gains in excess of the $1 million (or $2.5 million per couple when combined with existing real estate exemptions) as of the date of death. This will no longer allow for assets with large unrealized gains to escape taxation when passed down to generations upon death via a tax-free stepped-up basis. It appears that there could be exceptions to this tax liability upon death if the property either is donated to charity or is related to a family-owned business/farm that the heirs will continue to run.
Excess Business Loss Limitation
As part of the Tax Cuts & Jobs Act, section 461(I) was created to suspend excess business losses of non-corporate taxpayers if the amount of the loss is in excess of $250,000 ($500,000 if filing a joint return). Section 461(l) limits a taxpayer’s ability to utilize losses of their business to offset other sources of income (wages, portfolio income, etc.).
Although the Tax Cuts & Jobs Act limitation on excess business losses was set to expire for tax years beginning after Dec. 31, 2025, the American Rescue Plan Act of 2021 signed by President Biden earlier this year extended the loss limitation provisions for one additional year through 2026. The American Families Plan would permanently extend the section 461(l) loss limitation provisions, thus permanently restricting the deductibility of excess active pass-through business losses.
Expansion of the 3.8% “Medicare Tax”
The American Families Plan proposal also makes broad references to expanding the scope of the current 3.8% “Medicare tax”. This “Medicare Tax” comes in two forms: 1) Self-Employment tax or 2) Net Investment Income tax. The plan discusses the tax being more consistently applied on income earned in excess of $400,000. Although details are not yet available as to what type of income the Biden administration is targeting with this proposal, this could open the door to active income earned from rental real estate activities or earned through S corporations being subject to Self-Employment Tax.
It is important to note that this is President Biden’s “wish list” and is not necessarily a list of what will ultimately become law. There is a lot of negotiation to be had before a bill is introduced or enacted. However, the proposal provides a glimpse into what the President has his sights set on for tax reform and many of these items will have a significant impact on the real estate industry. For this reason, taxpayers should begin to consider what these changes could mean to them and their business.
This article was written by Scott Helberg, Jack Clarizio, Corey Pedowitz and originally appeared on 2021-04-30.
2020 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Pugh CPAs is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Pugh CPAs can assist you, please call 865.769.0660.
Call us at 865.769.0660 or fill out the form below and we'll contact you to discuss your specific situation.