If you are a real estate investor, you should read this article to the end, as the Joe Biden tax plan will likely affect you. The Biden tax policy, in a nutshell, has two main pillars:
- Raise the tax rate on the highest income bracket from 37% to 39.6% (that is, taxpayers earning $400,000 or more per year pay a bit more in taxes). As a way to generate more money considering the economic spends of Covid-19, moratoriums, and job losses, the Biden income tax plan would also bring back social security taxes for higher earners ($400,000+). Pre-Biden, you only paid social security taxes for the first $137,700 of income, and then social security taxes disappeared. Forbes has a Biden income tax calculator that shows how your taxes would change under the Biden income tax policy.
- The Biden tax policy change that most affects real estate investors is that capital gains taxes on sales of real estate over $1 million will be no different than the normal income tax rate. This means that investors selling $1 million+ worth of real estate in a year would have to pay the normal rate of 39.6% where it was normally 20%. Again, this only affects taxpayers earning $1 million per year. Accompanying this change are the proposed elimination of the 1031 exchanges (for investors with $400,000 or more in annual incomes) and the stepped up basis (for capital gains tax on inherited properties).
The Biden tax plan would also raise corporate taxes by 7%. Although it is a way to keep the wheels moving by generating more money to run other policies, for example, student loan forgiveness, it almost seems like the Joe Biden policies are aimed at the rich.
Experts predict it’s going to have unpalatable effects on the middle class. While talking about the Biden tax policy on Fox Business’s Mornings with Maria, Home Depot Cofounder, Ken Langone, said:
I don’t know if there’s any of us that have done well that will have a problem with paying more taxes, but it’s a ruse to think that hitting us and us alone is going to get the job done… It won’t and the middle class will be in peril and when you take money out of the hands of the middle class, you do a dramatic impact negatively on the economy.
What would be the impact of the Biden tax plan on real estate investors and property investments?
Effects of the Biden Tax Plan
Many investors have built their portfolios on 1031 exchanges. It seems that this loophole which allows you to defer the payment of capital gains taxes when you buy a property off the proceeds from the sale of a similar or higher priced property is going away for high earners. The Joe Biden tax policy seeks to eliminate the 1031 exchange for real estate investors earning above $400k in yearly income. While entry level investors can still use 1031 exchanges, high earning investors may have to hold on to properties for longer. This may have an effect on inventory levels for investment properties for sale.
Want to factor in tax expenses when calculating your rental profitability? You should try Mashvisor’s investment property calculator which features a tax calculator as well.
The opportunity zones program allows investors to channel capital gains generated from the sale of assets into qualified funds that make long-term investments into designated underserved communities. Investors enjoy preferential tax treatment. Win-win.
The Biden administration aims to screen out investors taking advantage of this real estate investing program for lucrative projects such as high end apartments instead of community-minded projects such as affordable housing. Under the tax reform, investors who qualify for tax incentives must provide detailed information about their opportunity zone investments – with emphasis on how the project yields social, economic, and environmental advantages. These requirements mean more bottle necks for investors hoping to take advantage of the opportunity zones program.
Under President Trump’s Tax Cuts and Jobs Act (TCJA), bonus depreciation was raised from 50% to 100% until Jan 1, 2021. While bonus depreciation didn’t apply to income properties (or assets with a useful life of 20 years or more), they applied to maintenance and home improvement purchases. For example, if a door replacement cost $1,500, you could use bonus depreciation to deduct the full cost of the door in the first year.
While Biden hasn’t directly proposed to eliminate bonus depreciation, he plans to pare down components of the TCJA for individuals with more than $400,000 or more in annual income. But bonus depreciation might go away if Trump’s TCJA was repealed. According to legal news website, Jdsupra:
If the TCJA were wholly repealed, then prior TCJA law (the PATH Act) would be in effect. This would result in the elimination of bonus depreciation, as bonus depreciation was set to expire in 2020 under the PATH Act.
Stepped Up Basis
A controversial point in the Joe Biden tax policy, which affects all income brackets, is the proposed elimination of the stepped up basis. This elimination will increase the tax basis for inherited assets to their full fair market value upon the death of the testator. This applies not only to real estate but also to heirs benefitting from assets such as stocks, bonds, and mutual funds. What it means for heirs inheriting a particular property or investment is that if you decide to sell, you will pay taxes on the difference between the original purchase price of the property and what it sells for today instead of just paying taxes based on what it sells for at current market value.
This means, if you sold an inherited property for $150,000 while current market value is $143,000, you would be paying $1,400 in taxes. If the testator bought the property for $30,000 ten years ago, with the elimination of the stepped up basis, you would need to pay taxes on the difference between current value and value at time of purchase ($120,000). That means you pay $24,000 in taxes – a significantly greater tax burden for investors looking to sell inherited assets.
First Time Home Buyer Credit
Among other proposed increases in tax credits (e.g., the Child and Dependent Care Tax Credit (CDCTC), President Biden plans to bring back the first time home buyer credit – a way to tackle the affordability crisis. This credit provides a refundable, advanceable tax credit of up to $15,000 for first time home buyers.
Qualified Business Income (QBI) Deduction
Another incentive many real estate investors enjoyed via the TCJA was the 20% QBI tax deduction. Under the new Biden tax policy, the deduction would be phased-out for taxpayers with income in excess of $400,000 and eliminated for rental real estate activities. Note that in the current tax season, qualified business owners are still eligible for a 20% QBI deduction.
What Can You Do as a Real Estate Investor?
- Consider applying for real estate professional status If your income is in the 400k+ bracket, this would allow you to apply your real estate losses to your other income.
- Consider creating an S-corp. S-corporations do not pay income taxes. Instead of registering as a self-employed individual, you might get more tax benefits with an S-corp, paying yourself less than $400,000 in yearly wage and receiving larger amounts through shareholder distributions. Even President Joe Biden seems to be a fan of this strategy.
- Think twice about selling when the Biden tax plan comes into effect. Although there are many more buyers than sellers in the current seller’s market, you might have to pay more in taxes if you sell real estate (especially high end or inherited) when Biden’s new rules come into play.
President Biden housing policy tends to favor affordable housing and non-discriminatory housing. For example, he announced an executive order for the Department of Housing and Urban Development to reinstate the “disparate impact” rule of 2013 that the Trump administration had rescinded. The rule addressed discrimination in the housing market by barring lenders and landlords and others in the housing industry from requiring criminal background checks for tenants or from using artificial intelligence to predict creditworthiness.
While there are the good, the bad, and the ugly aspects of Joe Biden tax plan, it is important to know that many of these are still proposed policies, yet to pass Congress. So which of Biden’s housing policies would affect you the most as a real estate investor? Drop your comments below.
Meanwhile, remember that with or without the expect tax reform, you should always conduct diligent investment property analysis before making a decision to buy or sell a house. Use Mashvisor’s real estate investment tools to evaluate the potential of your property. Sign up for a 7-day free trial now.