Biden’s proposed tax hikes could be a ‘double-edged sword’ for real estate – what homeowners and investors need to know

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As an extension of his $ 2.3 trillion infrastructure program, President Joe Biden rolled out a $ 1.8 trillion plan to meet other priorities including education and child care.

To fund the plan, the White House proposed to raise taxes on wealthy Americans, describing its tax reform program as one that “rewards work – not wealth.”

“The president’s tax agenda will not only cancel the biggest tax giveaways of 2017, but also reform the tax code so that the rich must follow the same rules as everyone else,” the White House said in a report. information describing the US plan for families. . “It’s important to note that these reforms will also curb the way the tax code widens racial disparities in income and wealth. “

The focus on the wealthiest Americans means that most households will not be directly affected by the proposed changes.

“Some have speculated that it will hit middle-class home sellers who sell a house in an expensive market and have over a million dollars in real estate capital gains, but it’s very rare.” , said Taylor Marr, senior economist at Real- brokerage immobilier Redfin RDFN,
-2.88%.
“Even in markets where house prices exceed $ 1 million, most of it is still financed by debt, not all of equity.”

Nevertheless, some of the proposed changes to the tax code could have an impact on real estate. Here’s what homeowners and investors should watch out for:

Which of Biden’s tax proposals could affect real estate

Biden proposed to increase the capital gains tax rate for households earning more than $ 1 million. The White House proposes to increase the rate to 39.6% for millionaires, against 20% where it currently represents the highest income in the country.

Additionally, the Biden administration has called for an end to the ability to “increase” the base cost of real estate when it is inherited. The increase allows heirs to calculate capital gains on the sale of a house or other property using the market value at the time they inherited it, rather than when it was originally purchased. The increase in the base can considerably reduce the tax burden of the heirs in these circumstances.

Finally, Biden calls on Congress to remove a special tax break for real estate investors, called a Section 1031 swap. Under this tax break, if owners of investment and commercial property use the proceeds from the sale of one property to buy another property within 180 days, they can then forgo paying capital gains and depreciation recapture taxes. The Biden plan would eliminate the possibility of doing this when capital gains are greater than $ 500,000.

Rising capital gains rates could be “a double-edged sword”

By design, increasing the capital gains tax rate will not directly affect most Americans. But among those affected, it could lead to two conflicting results, economists say.

“The current proposal to increase the capital gains tax could impact a larger segment of Americans than initially anticipated,” said George Ratiu, senior economist at Realtor.com. And it has a lot to do with the state of the housing market right now.

Many owners among the Silent and Baby Boom generations bought their properties decades ago, when prices “reflected a different economic environment,” Ratiu said. Today’s housing market is defined by high demand – driven primarily by millennials and low interest rates – and low supply due to decades of under-construction. As a result, home prices are rising at an all-time high, increasing the likelihood that a homeowner who bought their home years ago could realize significant capital gains if they sold it.


“The current proposal to increase the capital gains tax could impact a larger segment of Americans than initially anticipated.”


– George Ratiu, Senior Economist at Realtor.com

The proceeds from the sale of a home on top of these owners’ other income “could push more of them into the over $ 1 million range, which would result in a noticeable loss of appreciation if the current proposal was adopted, ”Ratiu said.

If that happens, homeowners are likely to respond in two ways, said Ralph McLaughlin, chief economist and senior vice president of analysis at real estate finance company Haus.

“It’s a double-edged sword,” McLaughlin said. “For those who were planning to sell in the next few years, the policy might encourage them to sell their investment properties earlier. “

This could inject much needed supply into the housing market at a time when buyers are struggling to find homes to buy. But it could have the opposite effect in the longer term, McLaughlin warned.

“I am concerned that the policy will lock in investors for a much longer period of time than at the current rate, and therefore be counterproductive in helping to free up investor stocks,” McLaughlin said.

Alternatively, some argue that the higher tax rate could simply cause richer Americans to reassess where to park their money. “I guess this increases the incentive for top earners to invest in funds in the opportunity zone and could therefore stimulate further development there,” Marr said.

Eliminating 1031 exchange could lower house prices

The 1031 exchange “has been the cornerstone of commercial real estate investments,” Ratiu said. A 2020 report from the National Association of Realtors found that 12% of sales transactions involved a similar exchange between 2016 and 2019.

Overall, the beneficiaries of these policies were small investors, the report notes. Almost half (47%) of the affected properties were owned by investors in sole proprietorships, while 37% were owned by S-corporations.


About 84% of the properties involved in 1,031 exchanges were owned by small investors, according to data from the National Association of Realtors.

“Removing this provision would likely lead to a downward adjustment in house prices,” Ratiu said, adding that investors could hold properties longer. Residential real estate markets would be impacted. Just over half of the properties affected by the 1,031 swaps were residential properties, including single-family rental homes, apartment buildings and condominiums.

Past tax reforms give cause for optimism

It wouldn’t be the first time that tax code changes have raised fears of a real estate slowdown. It was the same when President Donald Trump enacted the Tax Cuts and Jobs Act of 2017. The Republican tax reform package reduced the mortgage interest deduction and eliminated the ability to deduct state and local taxes.

“There were fears of negative effects in high-cost markets, but these appear to have been overcome by the stronger supply and demand dynamics,” said Tendayi Kapfidze, chief economist at LendingTree.

Some predicted that the tax burden could trigger a larger wave of exodus from expensive coastal real estate markets than was already happening then. But the 2020 census data presents a murky picture, and it’s not clear that high taxes alone have led to many changes in people’s real estate decision making.


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