Just a few weeks into office, President Biden is already pushing for a sweeping tax bill. This White House tax proposal is aiming to benefit moderate and middle income families. These families often make too much for government assistance, but too little to save for their futures. While these proposals are intended to tax the highest income individuals, these changes could have substantial impact on millions of Americans. Specifically, homeowners and real property investors should take note of Biden’s real estate tax proposals and the potential for property tax changes that would hurt their bottom line. Biden’s proposal includes changes to:
- The Estate Tax
- Social Security Tax on Wages
- Low-Income Renter’s Credits
- Ordinary Income Brackets
- Itemized Deductions
- Qualified Business Income Deductions
- Long-Term Capital Gains Rates
Estate Tax Exemption – The “Death Tax”
The 2017 Tax Cut and Jobs Act increased the estate tax exemption to $11.7 million per person. This means that upon death, a single individual can pass on $11.7 million worth of assets, including real estate, without taxation. This includes appreciated property, meaning that individuals can avoid paying capital gains taxes on highly appreciated assets. Biden’s proposal would decrease this number to $3.5 million, to ensure that wealthy individuals would pay their fair share of taxes.
Social Security Tax for High Earners
The current Social Security system is facing significant funding shortages. Yet, Biden has proposed further increases Social Security payments for Americans. To pay for this, he has proposed an increase in the Social Security payroll tax for some individuals. Currently, Americans paya 6.2% Social Security tax on only the first $142,800 of their income. Biden has been adamant that those who make over $400,000 should pay additional Social Security tax to make up for the current shortfall. This means that Americans would pay 6.2% on the first $142,800 in income, 0% from there to $400,000, and then face the new tax on all amounts earned over $400,000.
Renter’s Credit for Moderate Income Families
Biden’s proposal also includes a Renter’s Credit for low to moderate income families. Despite its name, the renter’s credit would be provided to landlords and real estate developers as a subsidy to keep rents low. Currently, Section 8 may cap rental rates to thirty percent of family income for low households. Many who live in high cost of living areas, such as New York City, may not be eligible for existing assistance because of income limitations. Despite earning more in larger cities, these families often pay much higher rental rates. The credit would effectively cap the rent at thirty percent of the renter’s income for low-income families who make too much to qualify for Section 8 assistance. This could be a great benefit for real estate investors looking to expand their market by lowering rental rates.
Ordinary Income Rates for High Tax Brackets
Ordinary income, meaning income that is not earned through investments, is taxed on a graduated basis. Biden has proposed a change that will increase the top tax bracket rate from 37% to 39.6%. This bracket includes only individuals earning over $400,000 per year. All other tax brackets would remain subject to current rates and the already in place adjustments.
Limitation on Itemized Deductions
Itemized deductions may allow taxpayers to significantly reduce their taxable income beyond the standard deduction. Generally, high income taxpayers benefit from itemizing deductions, because they tend to have more deductible expenses. In fact, only 10% of American itemize their deductions. Biden’s proposal would cap itemized deductions at 28%. To explain by example, a taxpayer in the highest bracket would save 39.6 cents for every dollar deducted (which is the proposed highest tax rate of 39.6%), Biden’s plan would cap this at 28 cents. This means they would still pay a 11.6% tax on amounts deducted. This cap would apply only to taxpayers making over $400,000 a year.
Phasing Out The QBI Deduction
Currently, taxpayers who own certain flow-through entities, such as LLCs or partnerships, can deduct up to 20% of their Qualified Business Income from their income. This is a great benefit to certain small business owners. Biden’s proposal will begin to phase out the QBI deduction for those making over $400,000 a year. This could have a significant impact on real estate investors and landlords, who may be benefiting from the current QBI deduction.
Long-term capital gains
New York has been running its budget at a deficit for years, which is why taxes in New York are so high. If you have been in the market for a new home or real property investment, you may be wondering what does under contract mean in real estate? It seems that every new listing is quickly “under contract.” This means that the buyer and seller are already in negotiations, but have not reached an agreement. We now see this happening quickly after listing because of the influx of money and buyers into the housing market. One reason for this is because of the current preferred treatment of capital gains income. While ordinary income is taxed at nearly 40% for the highest taxpayers, the highest capital gains rate is only 20%, and for lower earners is 15% or 0%. This makes real estate investments extremely tax friendly. Long term capital gains rates apply to any property held for investment, including:
- Real Estate
- Qualified Dividends
Biden’s tax proposal, however, may change this for high earners. Biden’s proposal would tax capital gains at ordinary income levels. This means an increase from 20% to nearly 40% on the sale of real estate. It is currently unclear who this would apply to, whether it be Americans earning over $1,000,000 a year, or $400,000. There are also other significant questions, such as whether this would apply retroactively, or only to new purchases. While most Americans don’t earn over $400,000 in a typical year, the sale of highly appreciated property in New York City can easily push a seller into the highest tax bracket, resulting in a surprise tax bill. Those who are currently thinking about buying or selling real estate in New York City should plan ahead and contact a real estate attorney in NYC to ensure they do not have a surprise bill come tax season.
Biden’s tax proposal is currently that – a proposal. However, smart tax preparation begins before tax season arrives. Biden has been touting his tax changes since the campaign trail, and it seems inevitable that a tax bill with at least some impactful changes will happen. Because of that, Americans, including those who invest in real property, should keep up to date on changes as these may significantly impact their buying and selling decisions.