President Biden’s Tax Agenda: Issues for Commercial Real Estate
NAIOP members had the opportunity to learn about the association’s legislative agenda and its priorities for 2021 during the virtual 2021 Chapter Leadership and Legislative Retreat, including specifics regarding what might await the industry on tax policy in the new presidential administration.
Some of President Joe Biden’s proposals offered during his campaign for the White House would have profound implications for the commercial real estate industry if enacted. Coupled with some of the elements of his robust policy agenda, the fiscal situation Biden inherits means that we can expect that there will be a lot of pressure to increase revenues in order to pay for politically popular initiatives in a fiscally responsible manner. As the nonpartisan Committee for a Responsible Federal Budget noted in a research brief, Biden’s campaign proposals would raise federal revenues between $3.35 trillion and $3.67 trillion over a decade, and would increase taxes for the top 1% of earners by 13% to 18% of after-tax income.
Much of these tax increases would have a direct impact on our commercial real estate investment. Of course, proposals made during the campaign do not always materialize in the face of changed circumstances or political and legislative realities. Having said that, proposals that are of particular concern include:
- Capital Gains Tax Increases. Currently the top tax rate on capital gains, which applies to higher-income earners, is 20%. President Biden would increase the capital gains rate for those with incomes of over $1 million per year to the top rate on ordinary income, which under his plan would increase to 39.6%. If you include the current 3.8% net investment income tax that is imposed on those earning more than $200,000 annually ($250,000 for married couples), then the increase would be from 23.8% to 43.4%, an almost doubling of the capital gains tax rate for high-income investors.
- Elimination of Tax-Deferred Like-Kind Exchanges (IRS Section 1031). Capital gains taxes can be deferred in cases of exchanges of property held for productive use in a trade or business or for investment, provided properties are “of like kind.” Biden’s campaign proposal included elimination of IRS Section 1031, which provides for this deferral, as a partial offset for increased spending on childcare and education initiatives.
- Taxing Carried Interests as Ordinary Income. A carried interest (also know as a “promote”) is a profits interest in a venture which exceeds the capital contribution made by the recipient of the interest. In the real estate context, a common practice is for investors (limited partners) which provide the funding, to give such an interest to the developer (the general partner) as a means of aligning their mutual interests in the ultimate success of the project. In other words, the recipient gets a share of any upside. Carried interests have traditionally been taxed as capital gains. Biden’s proposal would tax them as ordinary income, effectively raising rates on many real estate entrepreneurs from 20% to 39.6%.
- Increased Taxes on Pass-Through Entities. Biden would repeal the current 20% deduction for qualified business income earned by partnerships, limited liability companies, sole proprietorships, and other so-called “pass-through entities, for taxpayers earning over $400,000/year (Section 199A). Income earned by these entities would normally be taxed at the ordinary income rate (currently 37%). The 20% deduction effectively makes income earned through pass-throughs taxable at a 29.6% rate.
There are good policy-based reasons why these proposals would make unwise tax and economic policy. A meaningful differential between tax rates on capital gains and those on ordinary income is key for commercial real estate investment, to provide incentive to take on the inherent risk in a long-term, capital intensive investment which is the nature of real estate. The tax-deferral allowed by Section 1031 like-kind exchanges enables real estate investors to shift resources to more productive properties, or to change geographic locations. Because of accumulated depreciation allowances on real property, the added taxes on a sale of the real estate creates a “lock-in” effect. Elimination of Section 1031 would result in a significant reduction in real estate transactions, harming economic growth.
Taxation of carried interests was limited by the Tax Cuts and Jobs Act, passed in 2017, to those assets held for more than three years. This eliminated the potential to mischaracterize income which was more in the nature of ordinary income as capital gains. And the 20% deduction for pass-through entities was necessitated by the reduction of the corporate tax rate from 35% to 21%. Without it, pass-throughs would have been severely disadvantaged compared to corporations, with investment flowing toward the latter. Real estate is predominantly held in pass-through form, with 1.9 million real estate partnerships in the United States.
Undoubtedly, there will be much work to be done in the coming years on tax legislation. On these and other tax proposals of importance to our industry and NAIOP members, we will work with the Biden administration, members of the House and Senate, and with our industry association allies to ensure that the impact of tax changes on the health of the industry, and our economy overall, are understood and appreciated by policymakers.
