Buy or Sell
Now or Later?


By Tidemark Team

In our first three editions of Tidemark Talks we gave you an overview of three potential tax hikes that could impact your current real estate investment strategy. The American Families Plan, a sweeping social spending proposal from the White House, contains provisions to tax capital gains at ordinary income tax rates, limit 1031 tax-deferred exchanges to protect only the first $500,000 in gain and tax capital gains at death, effectively eliminating the step-up rule, a widely used estate planning strategy.

If passed as proposed, the new law would become effective on January 1st of 2022. Though, there is a possibility that the taxing of gains at ordinary rates would be applied retroactively to gains realized after April 28 of this year. Thankfully, most political and economic experts don’t see retroactivity surviving the debate currently underway in the House of Representatives and the Senate. For purposes of this post, we will assume that the entire package of tax hikes would take effect for the 2022 tax year.

While it is still tough to predict what portions of the American Families Plan will become law, every real estate investor should be taking a hard look at how it could impact their portfolio.  The Senate majority leader has set a goal to finalize the legislation using ‘budget reconciliation’ (a rule that allows legislation in the Senate to pass with just 51 votes) and have it on the President’s desk by the end of September. That would leave little time to take action in terms of selling or exchanging real estate assets. January 1 is less than 5 months away already, not a long time considering the illiquid nature of real estate assets that cannot be sold quickly like a stock or bond. Time, as they say, is of the essence.

What action should you take to prepare for this potential shift in the tax code? The answer depends on your investment timeline. The shorter it is, the more urgent the need act. For many of you, the tax obligation on your gains could rise to 57%, when state and federal taxes are combined, up from approximately 36% under current law. So, if you realize a capital gain of $2,000,000 after the law passes, you would pay approximately $420,000 more in federal and state taxes.

That is a staggering increase and it has already prompted many investors to take preemptive action. We speak with investors and owner/occupants every day who are considering similar action.

If your current strategy is to dispose of real estate assets in 5 years or less, now may be the time, as it would take several years to pass legislation that would repeal the proposed tax increases, given the current balance of political power. It takes a two-thirds majority in both houses of Congress to override a presidential veto, and the next presidential election doesn’t take place until 2024. So, whatever passes will be with us for years to come, and investors who had plans to sell but bet against the passage of these changes to the tax code, will either pay higher taxes or shift to a longer term hold strategy hoping for repeal. Either option could upset a lot of retirement plans for those in the Baby Boomer generation, who are turning 65 at a rate of 20,000 per day.

The interesting twist to this is that buyer demand, driven by low mortgage rates and lack of supply, is at all-time high and this intensity has driven prices up dramatically over the past several years. So, those who do decide to sell before a potential change in tax law, will enjoy receiving record prices for their properties from buyers who are ready, willing and able to close before the end of the year. The downside risk of selling now is missing out on potential further price appreciation if the American Families Plan fails to become law. However, if the decision has been made to sell in the near term anyway, the proposed tax law changes may be the catalyst to sell.

What should you consider? If your time horizon to sell is within the next five years, is this the time to sell at peak value, or should you hunker down and play the long game? We would be happy to discuss your options with you and your legal and financial advisors.