There are three ways in which the Biden tax plan could affect the investment strategy of "exchange until you die, then increase the basis"
Reduced availability of exchanges Section 1031
Elimination of the step-up base after death
Reduced availability of tax rates on long-term capital gains
Reduced Section 1031 Exchanges availability
Section 1031 exchanges are often targeted for dilution or elimination because many see it as the tax loophole of a rich person. But 1031 exchanges allow start-up investors to purchase duplexes and to spend half of their money to increase their wealth by successively buying larger property. And by increasing their wealth over time, when duplex investors retire, they can rely on their property investments to help them retire. Apartment
The Biden tax plan could phase out exchanges for taxpayers with income of over $400,000 for Section 1031. The devil is in the details — and what is needed for the taxpayer to determine whether the income is $400,000. However, creating a program that does not affect retirees and other taxpayers who are not rich will be challenging.
Suppose a business owner bought a $400,000 building. They use the building for 25 years and downgrade it to a zero level. The sale of business property is part of the retirement plan of the owner. The company owner expects to receive $30,000 in social security per year and $25,000 in pension earnings per year.
If the business owner is willing to retire, the building will be sold for $750,000 and an exchange in Section 1031 into the revenue-producing investment property is expected. When they don't exchange section 1031, they have long-term capital gains of $350,000 and recaptured depreciation of $400,000.
If the revenues from the building sale are included in the revenue, they will have over $400,000 in the year the building is sold. They could be prevented from an exchange in Section 1031 even though their sole revenue is Social Security and pension accounts.
The hypothetical income of the business owner prevented them from benefiting from an exchange under Section 1031. They would pay $70,000 in tax on capital gains in the long term and about $134,000 in income tax without taking into account the increase in Biden's tax rate. It would leave them with $214,000 less in retirement and an annual retirement income of $10,000-$12,000 less than they had anticipated.
Removal of the step-up basis
With the increase in the 2025 sunset of the estate tax exemption, taxpayers would expect to reduce the estate tax exemption to previous levels. The Biden tax plan would immediately reduce the exemption to $3,500,000.
In addition, there is a proposal to eliminate the step-up basis. In that case, the property could pay property tax on 100% of the value of property, AND the heirs would later owe capital gains on any predeath gains on the property for which property taxes were paid.
Increased rate of capital gains
In addition to increasing income tax rates for higher income taxpayers, the Biden tax plan would increase the long-term capital gains tax by 20% to a much higher standard income rate, thus reducing this to 39.6%. The current proposal would affect only taxpayers earning more than $1 million.
This change would have an impact on our hypothetical business owner if he sold the property for $950,000 rather than $750,000. While $950,000 sounds like a lot of money based on a pension income computer, it only generates approximately $38,000 in annual income for someone who is 67 years old and places them in the medium class.
What Immobilien Investors Should Do Now
If the entire Biden tax plan is adopted, the tried and true Section 1031 exchange strategy until death and then the improved basis for many contributors may no longer be feasible. To determine whether a change to plans is warranted, investors should evaluate their tax situation. Although the situation of each taxpayer is unique and we do not know the exact changes in tax, certain strategies must be considered:
Give assets to benefit from the current tax exemption rates
Change in depreciation strategy over the holding period to minimize sales gains
Acceleration of disposition plans and full exchange of section 1031 prior to any tax changes
Do not exchange Section 1031 and pay capital gains rates for gains now
Payment sales to spread revenue from provisions
The exchange of Section 1031 into several smaller assets and/or common tenant or Delaware statutory trust investments is therefore available at disposition. Section 1031.