On Wednesday, April 28, President Bident released his American Families Plan. The Plan is a long way from becoming law given the divided Senate, and, if anything passes, it is likely to be different than the outlines in the Plan. Significantly, the Plan does NOT mention effective dates, which are likely to be part of the legislative horse trading, IF tax legislation can even be passed.
But, some of its tax provisions (we do not cover all of them here) seem to be particularly important for apartment owners. And, some provisions which we feared, but were not included, may be as important as the ones that the Plan included.
THE BAD NEWS
Increase in Top Income Tax Rate – The Biden Plan would increase the top income tax rate to 39.6% from 37%. Sources indicate this rate would kick in above about $509,000 for married couples filing jointly, and about $450,000 for singles.
Reduction in Basis Step-Up At Death
One of the great advantages of real estate investing comes from the ability to shelter income with depreciation, while property increases in value, and then get a step-up in income tax basis to fair market value at death. When it works, you and your heirs never recapture the depreciation, and do not face any gains on sale after death except to the extent of post-death depreciation and appreciation.
The Biden plan proposes to limit the “step-up” to $1 million per person, or $2 million per couple (potentially $2.5 million when you include $500,000 for a principal residence). The proposal hints at additional protections for family-owned businesses and farms, but does not spell them out in detail, and the tax law generally does not treat income producing real estate as a family business.
While the limited step-up the Plan proposes is better than nothing, many apartment owners will, by the time they pass, have property with values far greater than $2.5 million above their (depreciation reduced) income tax basis. On the other hand, some clients have delayed planning for estate taxes in order to keep property in the estate and get a step-up in basis for income taxes. That may no longer be advantageous.
Remember, at just 5% per year growth, property more than doubles in value every 15 years. If you bought property for $2 million 20 years ago, it may well be worth $5 million or more today, but have a depreciated basis of less than $1 million. In 15 years, it may be worth $10 million, so a $2 million step-up may not be much help.
Higher Capital Gains Taxes
For taxpayers earning more than $1 million, the Federal capital gains rate (and rate on qualified dividends) would rise from 20% to 39.6% (this rate would also apply to other income for those earning more than $1 million). Coupled with the 4.3% Medicare tax (which may apply to all income over $400.000 in a year), and California taxes, the total could be over 50%, and that would be collected from you if you sell, or from your heirs when they sell.
The potential for a higher capital gains rate, coupled with the limitation on the step-up in basis, may motivate some clients to sell property or engage in deferral strategies such as installment sales or charitable remainder trusts to stay under the higher rate applicable to earnings over $1 million.
Eliminate “Like Kind” Exchanges for Gains in Excess of $500,000
A “like kind” exchange transaction qualified under Internal Revenue Code ‘ 453 allows you to swap one real estate investment property for others and defer capital gains taxation. The Biden Plan would eliminate the deferral for gains in excess of $500,000. This would be a very adverse development for owners who have done exchanges into DSTs or other joint arrangements, which are likely to “roll-over” (leading to recognition of gains at that time), as you would no longer be able to “swap ‘til you drop” and get an unlimited step-up in basis.
THE GOOD NEWS (SO FAR, but with no guarantee
things will not get worse when a law is actually enacted.)
No Change Proposed to Estate Tax Rules
Unlike the bill introduced by Senator Sanders, the Biden plan did NOT propose to change the favorable estate tax rules signed into law by President Trump. So, the estate tax exclusion will remain at $11.7 million this year, and will grow with inflation until 2026, when it is automatically cut in half (probably to about $6 million per person). And, several provisions proposed by Sanders to eliminate favorable strategies to protect from estate taxes were not included in the Biden Plan.
So, for those anticipating an estate over the exclusion, we may still have time to plan to eliminate estate taxes through good planning. However, if your estate is likely to grow, these strategies work best when implemented early, and we cannot be sure how long Congress will leave the strategies in effect.
No Capital Gain Recognition on Gifts or Death
Other Senators have proposed taxing capital gains when you give property away, or die. The Biden Plan, fortunately, did not appear to include those provisions YET. However, it is likely that Democrats will continue to try to impose such taxes, which may be an additional motivation to seek to get property out of your estate now.
THE BOTTOM LINE
If you think your estate will grow to a level that might face estate taxes, you should meet with an estate planner familiar with advanced planning for income property owners to help you evaluate your planning options. Fortunately, modern estate planning strategies can, at least until the law changes, allow you to both protect against death taxes AND preserve resources to take care of you and your spouse during your respective lives.
Kenneth Ziskin, an estate planning attorney, focuses on integrated estate planning for apartment owners to save income, property, gift and estate taxes. He also provides trust and probate administration assistance after the death of a loved one. He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, a perfect 10 out of 10 rating from legal website AVVO.Com, and is a multiple winner of AVVO’s Client Choice Award. See Ken’s website at www.ZiskinLaw.com.
Ken also offers CONSULTATIONS FOR AOA MEMBERS in appropriate cases. Call him at (818) 988-0949. This article is general in nature and not intended as advice for clients. This article may be considered attorney advertising. Please get advice from counsel you retain for your own planning. (Drafted in late March, 2021.)