On November 3, the U.S. experienced a major divide when one of the most contentious elections in history took place between President Donald Trump and President Joe Biden. This is not to get into politics or election outcomes, but rather to focus on how President Biden’s changes will impact how commercial real estate is taxed.
Let’s take a closer look as to how Biden’s proposed tax plan includes a new probate real estate tax that could cause a massive hit on capital gains.
As proposed by the President, his new probate real estate tax would end the process of real estate heirs taking probated property on a stepped-up basis and, instead, require them to pay capital gains taxes on all appreciation that accrued on the property before their inheritance. This would put heirs on the hook for paying capital gains taxes on the appreciation of a property, plus any other profits earned above the current market value once the heir sells the asset.
Existing law is much more favorable to those who inherit real estate. For example, if someone purchased a property when it was valued at $100,000 and died when it had reached a fair market value of $1 million, the owner’s heirs would inherit the property at a stepped-up value. As a result, heirs under current law do not have to pay capital gains on the $900,000 in appreciation that accrued before the original owner’s death, and if they were to sell the property down the road, they would only pay capital gains taxes on any value above $1M.
President Biden’s proposed tax changes, as a whole, would essentially add a fourth tax bracket to the capital gains schedule of 39.6% on income above $1 million, meaning the top rate could reach 43.4% when we include the 3.8% net investment income tax.
How This Affects Real Estate Investments
When your parents pass and leave you the family house normally you inherit that property at what it is worth today. If you would sell that house, you would only pay taxes on what it is worth today and what it sells for. If President Biden does away with the stepped-up basis you will inherit the property for what your parents paid for the property. If you decide to sell you will pay taxes on the difference between the original purchase price and what it sells for today. In addition, this stands to greatly harm multigenerational ranches and farms by killing the next generation with taxes.
There’s More to Iron Out
First, the change is far from a done deal as President Biden’s plan could change or be voted down by the legislative branch. Then there are some unknowns in President Biden’s proposal, and how those are worked out could make the tax changes less of a blow, or even worse. For one, it’s unclear if death itself becomes a “taxable event” that forces heirs to pay capital gains taxes on all appreciated value at the time of their inheritance. It’s also possible that President Biden’s plan may allow heirs to inherit real estate on a carry-over basis, so they only have to pay for the years of appreciation when they sell the asset, not at the time of inheritance. Another option is that heirs could spread their taxes out over time.
The Big Takeaway
Personal views and politics aside, the thing that matters most is to pay attention and do your own research. Many changes will be coming down the line in the coming weeks and months as the Biden Administration moves into office. It’s common for rapid-fire policies to be rolled out in the first few months to kick start all the changes that were promised during the campaign. So be diligent about seeking out trusted news sources and knowledgeable advisors who can guide you in the right direction for your commercial real estate investments.
Mike Kushner is the owner of Omni Realty Group in Harrisburg.