Eric is a real estate investor, founder of MartelTurnkey and author of: Stop trading your time for money.
Does President Biden’s recently announced American Families Plan spell big trouble for the real estate market? Let’s take a look at the details to better understand the implications of this potential bill.
Broadly speaking, the American Families Plan is an investment in human infrastructure such as childcare and education. That’s the beauty of the program. The disadvantage? Higher taxes will be levied to pay for these programs.
To be clear, at this stage, the American Families Plan is just that: a plan, not yet a bill. Some details still need to be worked out. For now, though, let’s focus on three specific proposed tax increases that specifically target real estate and determine how it will affect our investment strategies.
My view is that real estate is one of the last remaining investment opportunities that 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. In addition to a real estate portfolio, a family business is not so easy to transfer and children are often not interested in continuing the family business for several generations. Generating passive income through real estate investments is therefore an ideal way to shape the financial future of your children.
The first change proposed by the Biden plan is to increase the capital gains tax rate to 39.6% for households earning more than $1 million. Currently, the long-term capital gains tax, at the highest level, is 20%. Will this increase actually kill real estate? Probably not, but it will likely discourage and/or delay property owners from selling. Property owners may choose to refinance their existing properties for their next purchases, reducing the supply of available buildings to buy, driving prices up. That said, chances are someone who makes more than a million dollars a year has a team of tax attorneys with strategies for avoiding this type of tax. For example, opportunity zones, endowment plans, and other strategies can still be implemented to avoid paying taxes on them.
Another big change to this plan: withdrawing the 1031 exchange for profits over $500,000. Above that number, you would have to pay 39.6% capital gains tax. This tax deferral is critical to wealth building and multigenerational wealth creation. What consequences does this have for real estate? For example, investors who own apartment buildings will likely wait to sell those properties until the capital gains or 1031 bills of exchange become more favorable to them. Instead, they can turn to smaller single-family homes to avoid the 1031 exchange. This would then reduce the demand for multi-family homes, but increase the demand for single-family homes and raise their prices. This would be detrimental to middle-class Americans trying to take that first step in buying real estate and building wealth in the long run. And if people just want to buy a house to live in, house prices will also rise as investors move into homes.
The third major change is to eliminate the increased base for gains in excess of $1 million ($2.5 million per couple “combined with existing property exemptions”) and tax the profits if the property is not donated to charity. . The reform will be designed “with protection so that family businesses and farms do not have to pay taxes when given to heirs who continue to run the business.” For some reason, real estate investing is not considered a family business. Most likely, illiquid assets will be able to pay the tax over a longer period of time, perhaps seven or more years.
This would have a dramatic effect on the prosperity of several generations. The incremented basis states that upon death, the value of your property and assets will be “boosted” to their current market value. If the beneficiary of the estate decides to sell immediately, he pays no capital gains tax. As you can imagine, it is a great way to pass on wealth to your children.
Imagine your parents had a house in California, bought 40 years ago for $300,000. After their deaths, the souped-up base now values the house at $2 million (not a crazy valuation in California, trust me). You can sell your parents’ house for $2 million and pay no capital gains tax. Under the proposed new Biden plan, the first $1 million would be exempt from capital gains tax, but you would pay 39.6% tax on the remaining $700,000 whether you sold the property or not. That would equate to over $277,000 in taxes to be paid upon the death of your parents, compared to nothing today.
So, who will be most affected by this new plan? I tend to have a cynical view and assume that the very wealthy will rely on tax lawyers to protect their assets. Their children don’t have to pay taxes while still controlling their equity. Instead, the middle class, which doesn’t have the resources for expensive tax lawyers or the time and resources to come up with new investment strategies, will eventually take the burden of this new plan. I also believe that the plan will affect the ability of the middle class to invest in real estate, achieve financial freedom and leave a legacy for their children.
Will the Biden American Families Plan Destroy Real Estate? Of course not. Investors and entrepreneurs are resourceful and always adaptable. Real estate remains a strong investment; it will simply mark a major shift in the types of assets being invested in. I expect housing prices to rise as demand increases. I hope you found this article helpful and insightful.
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