In late April 2021, President Joe Biden’s Administration proposed the $1.8 trillion American Families Plan (AFP), designed to aid lower- and middle-income families. Substantial revisions to existing tax policy would be needed to fund the plan.
In its existing form, the AFP would result in significant changes for individuals earning more than $400,000 annually. The changes would include increasing the long-term capital gains tax rate, and for those earning more than $1 million annually, reclassifying carried interest as income rather than a lower-taxed capital gain.
These alterations to taxation would likely affect the multifamily industry in at least three ways.
- First, investors and general managers and partners who fall into the top tax bracket would see lower net income.
- Second, this lower income would possibly result in the diminished ability—and possibly desire—to invest in additional real estate ventures; sales transactions may slow. The higher taxes may discourage partnerships from investing in new builds just as more multifamily housing is needed to address the perpetual housing shortage.
- Third, it is possible this tax environment may cause investors to increasingly consider Opportunity Zones, which offer the benefit of tax deferment.
The proposed AFP will also erode the 1031 exchange by eliminating the tax deferment if the exchange results in an initial gain exceeding $500,000. This alteration to 1031s could spark a selloff of properties held in exchanges prior to the implementation of the AFP. Following implementation, some investors would be inclined to hold on to 1031 properties, hoping a future administration restores the tax deferment.
The stepped-up basis on death takes the value of a property at the owner’s death and applies that value to the earlier date which the owner purchased it, effectively eliminating the immediate capital gains tax liability to the heir(s). The AFP proposes elimination of this tax relief, which would place a tremendous tax burden on heirs to property.
All these tax changes are proposals and will be reviewed by Congress later in 2021. Even now, some members of the majority party are suggesting they will resist passage of some of these tax changes, suggesting that they are too extreme. Additionally, many members of Congress would be adversely affected by these proposals, making them less likely to pass them in their existing form.
Sources: Commercial Property Investor; Investopedia; MarketWatch; Multi-Housing News; National Multifamily Housing Council; Urban Institute & Brookings Institution; WealthManagement.com; The White House.