As I write this article 35 days before the election, and just one day before the first Presidential Debate, I have no idea who will win the election. But, by the time you read this article, you will probably know, or have a good idea, who won.

If it looks like President Trump will be re-elected, most of your tax planning will probably not need major revisions. However, if it looks like Biden will win, major changes in tax law are likely.  These changes may make it prudent to try to make major changes in your estate planning and investment structure.

 

Of course, no one knows what Biden will actually propose to Congress if he is elected or what Congress may actually enact (or when).  But, we have a few ideas from what the candidates have proposed, and how major accounting firms have interpreted the proposals.

And, we know that the deficit has mushroomed far beyond what was projected just 10 months ago, as a result of the “Virus Deficit.”  At some point, any Congress or Administration may decide it needs to make changes to the tax system to reduce the deficit, or at least reduce the rate at which it grows.

I also worry that, even if Biden does not win or he cannot get his proposals enacted in 2021, other trends may lead to adoption of similar proposals at some time in the future.  I believe the Democrats, when and if they have the power, would prefer to tax the “rich” than tax everyone.  And, their definition of rich is likely to be a lot lower than yours.

So, let me get out my crystal ball (which will not prove perfect) to give you an idea of some major changes you might anticipate.  I will also try to give you a few planning ideas if you want to be proactive in protecting your family and your portfolio from confiscation by the government. [This summary has dealt with the tax proposals which I believe have the greatest importance for apartment owners.  There are many other proposals that may be significant for your individual tax situation and planning.]

 

Can You “Beat The Clock?” – A Warning on Effective Dates

Usually, effective dates are one of the last things anyone worries about.  But, in this era, with Congress more aware than ever of planning for “tax avoidance,” we worry a lot about effective dates. The fact is that new laws can be adopted that retroactively tax transactions occurring before the date of enactment (when Congress adopts the law and the President signs it).

Many of us worry that some or all of the new provisions will have an effective date earlier than the date of enactment.  Commonly that might be the date legislation is introduced in Congress.  But, it could be as early as January 1, 2021.

So, for major changes or transactions you want taxed under old law, to “beat the clock” we recommend, where possible, that they be implemented before the end of 2020 or as early as possible in 2021. We realize, however, that may not be possible for everyone.  Fortunately, retroactive effective dates are not common, so if you do not complete planning by year end, you may still be able to plan if you get it done early in 2021.

 

On the One Hand, What If Trump Wins?

If Trump wins, the odds favor seeing little in the way of tax changes that would motivate changes in your planning.  Note that, unless the GOP gets control of the House of Representatives, he may be unable to expand tax breaks even if he wants to do so.

Trump has proposed making some of the “temporary” changes from the 2017 tax act permanent, These would include making the 37% top income tax rate, the 20% Qualified Business Income (“QBI”) deduction, and the expanded estate tax exclusions “permanent.”

Remember, however, that “permanent” just means these provisions do not automatically expire in 2026 as currently scheduled.  A future Congress and Administration can still expand or reduce “permanent” changes.

Trump has, however, proposed one change apartment owners will probably LOVE:  Indexing capital gains for inflation.  IF indexing is adopted, some or all of the gain you realize that reflected inflation would cease to be subject to capital gains tax at the Federal level.

 

On the Other Hand, What If Biden Wins?

If Biden wins, we think it is likely, though not assured, that we will see major changes proposed, and perhaps adopted, to the tax system.  Of course, the ability to enact changes will also depend on the makeup of Congress.

Nonetheless, it looks like the Democrats will keep control of the House of Representatives, and have a decent chance to get control of the Senate.  And, if they fail to get control of the Senate, but get closer to it, pressures on the deficient and national debt may still enable adoption of some tax increases.  So, let’s consider some of the likely changes on Biden’s “wish list.”

 

  • Repeal Most of the Tax Cut and Jobs Act (the “TCJA”)

Most commentators believe Biden would seek to repeal most of the provisions of the TCJA which help the wealthy and apartment investors. This would raise the maximum income tax rate from 37% to 39.6 percent, and tighten several of the rate brackets below that rate.  So, it may not be wise to defer income from late 2020 into 2021. It would also eliminate the QBI deduction, reduce thresholds for the alternative minimum tax and make changes to estate and gift tax rules (discussed in a little more detail below).

On the plus side for many taxpayers, the $10,000 per year limit on “SALT” (state and local tax) deductions may also be eliminated (though deficit pressures may lead to retention of the SALT limits). Also, if you have substantial earnings subject to the Social Security Tax, such earnings above $400,000 would lose their exemption.

 

  • Repeal of 1031 Deferral for Like-Kind Exchanges

For decades, real estate investors have been able to defer capital gains by doing like-kind exchanges.  In many cases, the deferral becomes permanent if you die holding the “up-leg” property. Biden proposes repealing it for taxpayers with incomes above $400,000.  So, if you have substantial income, or would without the benefit of the ‘ 1031 deferral, and want to diversify, you may want to complete the exchange before the effective date of any Biden change in ‘ 1031.

 

  • Tax Capital Gains at the Same Rates as Ordinary Income

Biden proposes to tax capital gains at ordinary income rates for taxpayers with more than $1 million of income.

Of course, for apartment owners who sell property, gains are likely to put them above $1 million. Combined with the increase in top rates and the repeal of ‘ 1031 exchanges, this could be a massive increase in tax for apartment owners who sell property after the effective date of Biden changes.  The rate could go from nothing currently, to 39.6%.

And, if you had deferred income through exchanges or a Charitable Remainder Trust (“CRT”), you could see the deferred income taxed at higher rates than were in effect when you did the exchange or gift to a CRT.  It means you need to carefully consider whether deferral will prove beneficial, or detrimental.

 

  • Estate and Gift Tax Exclusion Rollback

Since the late 1990s, we have become used to expanding exclusions from Estate and Gift Taxes. The exclusion has grown to $11.58 million per taxpayer, and is scheduled to grow with inflation through the end of 2025.  Then, it automatically gets cut in half (probably to around $6 million). Biden, however, proposes rolling the exclusion back to 2009 levels.  That would suggest an exclusion of just $3.5 million per person, and rates increasing from 40% to 45%.

 

  • Repeal Step-Up in Basis at Death

Biden has also proposed repealing the Step-Up in Basis at death.  The Step-Up adjusts the income tax basis at death on property in your estate (and in certain trusts) to the fair market value at your death.

So, if you bought a property for $1 million years ago, have depreciated it down to $500,000, and you die with it in your estate when it is worth $2 million, Step-Up gives your heirs an income tax basis of $2 million, and permanently avoid taxation on $1.5 million of capital gains. [California also recognizes the Step-Up].

But, if the Step-Up is repealed, between Federal and State taxes on capital gains, at rates proposed for 2021, that may mean $750,000 of tax if your heirs sell at date of death value.

Furthermore, if your heirs continue to hold income property, the Step-Up can permit increased deductions for depreciation (as though they bought the property for the FMV at death).  Such deductions can shelter all or most of the income from rental property from Federal and California income taxes.

The combination of low capital gains taxes, the ability to do exchanges, and the Step-Up in basis have been the cornerstone of the tax advantage of investment in income producing real estate.           Sadly, this advantage may disappear under a Biden tax revolution.

We worry that, absent this tax advantage, the value of income producing real property may also decline, particularly in a high-tax state such as California.  The decline may be accelerated by tougher rent control and/or reduced ability to prevent reassessment for property taxes.

 

THE TIME FOR PLANNING IS NOW

My estate planning motto has never been truer.  Now more than ever: If you fail to plan WELL NOW, plan to FAIL.” None of us know what the laws will be like in the future.  But, I believe that, at some point, the tax environment, particularly in California, will become much more adverse for apartment owners.    Some of the changes may be ones about which you can do nothing.

However, if you plan in time, you can protect your wealth from estate and gift taxes by using your existing exclusions.  Fortunately, modern estate planning can help you get property out of your estate and STILL retain access to it in case you need it to maintain your lifestyle.

The bottom line:  If you think your net worth could grow before you pass much above $3.5 million as an individual, or $7 million as a couple, PLEASE spend some time with an experienced estate planner as soon as possible to evaluate what you can do to protect your wealth from substantial death tax exposure.  This is particularly urgent if it looks like there will be a 2021 change in administration.  .

Don’t let procrastination allow changes in the law to steal decades of sacrifice and hard work from your family.

And, please do not wait until new laws have been introduced in Congress or adopted.   It takes time to plan these strategies well in the context of your family situation.  It takes even more time to implement them in the best way.  You should not expect planning done under the pressure of a change in administration, or a pending effective date, to work as well for your family as planning that starts sooner.

We have learned from years of experience planning for owners of income properties that they care about planning for the future.  Most of you have sacrificed for decades to build wealth not for you to spend, but to benefit your heirs.  You probably did not build this wealth just to see much of it taken in unnecessary taxes when you die.  Don’t let a change in administration blind-side your family.

If you want to consult with me and my wife Hinda, we would love to conference with you by video or phone (until the Covid risk of in person meetings has faded).  Such a conference can help you evaluate your risks and planning alternatives.  But, if you do not do a conference with us, please find an estate planner familiar with a range of advanced strategies who is also well-versed in issues relevant to the owners of income properties.

 

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 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.  He may be reached 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 September, 2020.