Most people looking to buy or sell a house or connected with real estate were eager to know about the proposed tax policies and changes. Will the democrats’ tax increase affect real estate market in 2022 or beyond? Let us explore.
These new tax policies will mainly affect the wealthy, corporate houses, and real estate investors. Accounting Today quotes,
“The biggest tax increase in a generation took a major step forward with proposals of $2.1 trillion in potential tax levies.”
Before going into details, it is crucial to know that these are only the proposed changes and have not been signed into law yet. There are chances that many of these may still change and not even become law. It is advisable not to make decisions based on these changes before consulting some experts.
When the tax rates change, they affect real estate investors differently. It is not that if the tax rates increase, your tax burden will also increase. Even if the democrats’ tax increase affect real estate market it should not be a burden on you if you plan correctly. It all depends on what your financial standing is. But if you think that, why discuss these tax changes before they become law? Then the simple answer is that if you want to take complete advantage of your tax savings, you need to make well-informed decisions with all the information at your disposal. When these changes become actual laws, you might have limited time to make crucial decisions.
Self-directed retirement account investments
Sometimes real estate investors use retirement money to invest in real estate. This self-directed investment in different real estate deals helps them to be safe from penalties and current taxes. These investments can be of several types, like rental properties, notes, syndication, etc. The proposed changes
may restrict Individual Retirement Accounts (IRAs) from investing in debt securities, private equity, and other investments. Most of these investments need the IRA owner to satisfy educational, financial, and licensing pre-requisites.
If you want to invest your self-directed IRA in some deal that requires the investor to be officially recognized or authorized, the new proposed changes can be a problem for you. If these proposed changes are enacted into law, you must dispose of the interest or move it to another account before December 31, 2023. Failing to do so on time may incur potential taxes and/or penalties of over 50%.
If this law forms, investments in any real estate syndication using self-directed IRS may not remain a favourable option anymore. The proposal further prevents the IRA from becoming an owner of more than 10% of the investment, and the IRA will not be able to invest in any entity where he is an officer.
These proposed changes prohibit IRA investments into standard procedures like blocker corporations, Checkbook IRA LLCs, Joint ventures, and trusts. So it is not necessary that democrats’ tax increase affect real estate market in a direct sense.
Changes in Tax Rates – Will democrats’ tax increase affect real estate market?
We have been hearing about the potential increase in the tax rates by democrats for some time now. The proposed changes may increase the highest federal income tax rate from 37% to 39.6%. It will be applicable to single taxpayers if their income is over $400K and for married couples, if their joint taxable income is over $450K.
The proposed changes aim to raise the tax rates and lower the income level at which higher tax rates become applicable. It means that now more people will come under the highest tax rate bracket paying a good part of their income in taxes. Now the question is, why should we consider ordinary tax rates here?
It is because with real estate, most incomes like flip income, rental income, property management income, etc., have ordinary tax applicable. Another significant change that is expected is related to C corporations. These changes plan to increase the highest C-corp tax rate from 21% to 26.5%. This change will only impact C-corps with an income of more than $5 million. Thus it is clear that those saying that democrats’ tax increase affect real estate market are not true.
If you are an average real estate investor using C-corps to earn property management income, the proposal aims to lower the tax rate to 18% on the first $400K of the taxable amount.
Capital Gains Taxes
Many investors are also interested to know what these proposed changes may bring to the capital gain taxes. The proposed changes may get some good news for higher-income taxpayers that the capital tax may increase from 20% to 25% and not 39.6%. It would be strange that higher capital gains tax rate would apply to the gains acknowledged on or after September 13, 2021. So if you have sold some of your assets before this date, they would incur the lower capital gains tax rate and vice-versa.
If you entered into a transaction in August 2021 but closed it only after September 13, 2021, a lower tax rate will still be applicable on the transaction. Some examples of capital gains are selling business assets, rental property, stocks, and primary homes.
Business Income Taxes
The proposed changes may also affect the higher-income taxpayers with their business come. Net Investment Income Tax will then apply to the ordinary business income. In the past, high-income taxpayers paid this tax only on their investment income. But if enacted as law, the proposed changes would also look to tax this on business income. It would be an additional load of about 3.8% in addition to the already applicable federal and state income tax.
An ordinary income from a business in real estate may include flip profits, income generated from commissions, property, asset management income, etc. Married couples with taxable income of more than $500K and Single taxpayers with taxable income over $400K will be affected by this change.
Are the proposed changes suitable for real estate investors?
Not everything is terrible in the new proposed changes for the real estate investors. Investors are not worried if the democrats’ tax increase affect real estate market. There are a few good things that we did not see in the proposed changes. These are related to the removal or limiting of the 1031 exchange benefit. It is a situation where the investor can defer the taxes by selling an appreciated rental property and replacing it with some other property.
The proposed changes do not mention the 1031 exchange benefit, so it can be considered good news for real estate investors. The proposed changes do not mention the bonus depreciation, general business write-offs, and tax benefits for real estate professional status. So we can believe that these also will still stay.
It is always a good idea to under how the proposed changes if enacted into laws, may affect you and plan your tax and investment decisions accordingly. It is also helpful to get in touch with the advisors and prepare for tax changes.