The White House is developing a proposal to raise the capital gains tax to 39.6% for individuals making more than $1 million a year. And during the campaign, he said he wanted to completely end the 1031 exchange tax break.
Although all of this is currently speculative, if any went through, the real estate industry would have cause for concern.
“Real estate has long had a pretty good deal,” Jessica Millett, a partner and chair of the tax department at real estate-focused law firm Duval & Stachenfeld, tells GlobeSt.com.
That had continued through the 2017 Tax Cuts and Jobs Act, which limited some corporate and individual tax breaks. “For virtually every limitation that Congress put into the 2017 tax act, there was usually a ‘but real estate gets a better deal’ [caveat],” Millett says.
An increase in capital gains for the wealthiest individuals doesn’t mean an end to real estate investment, as other sectors would face the same limitations. But it could result in significantly different strategies, with less turnover.
“If a property is cash flowing, and has positive equity, an investor will be likely to hold in hopes that the capital gains rate is reduced in the future,” Scott A. Johnson, chair of Eastman & Smith’s real estate practice group, tells GlobeSt.com.
An end to the 1031 deferral would likely reinforce a slowdown, as it would “further encourage an investor to hold real estate investments in hopes that the capital gains rate is reduced by a future administration,” Johnson says.
“It stimulates the investment,” Reid Thomas, chief revenue officer and managing director at JTC Americas, formerly NES Financial, says to GlobeSt.com. You’re able to sell one asset, take the gain, and put it into another.”
The biggest losers might not be the biggest players. “The majority of the transactions are relatively small residential real estate,” Thomas says.
And those with large exposure as qualified intermediaries could find themselves without business.
“It’s difficult to make broad market predictions, but it would seem fair to speculate that it would create downward pressure on asset values across all sectors, including CRE, with impacts varying depending on the relative amount of the sector‘s assets held by investors taxable in the US,” Baker Botts partner Matt Donnelly tells GlobeSt.com.
The triple threat would be a simultaneous end to the 1031, basis step-up on death, and doubling of capital gains. “Those have been three things in particular so near and dear to the real estate industry, a lot of people view it as part of the fabric of real estate investment,” Millett says.
But Millett adds that investors shouldn’t worry too much. “Every single day new tax law is coming out, new guidance is released,” she says. “Even though this may feel like the sky is falling, there will be something else coming along to incentivize investment if you can get the right lobbyists in Washington, D.C.”