With one of its own in the White House, the commercial real estate sector was treated well by the Trump Administration. The property industry benefited from generally pro-business policies and as well as more relaxed banking and environmental regulation. Investors benefited from President Trump’s signature legislative achievement, the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. The new tax code provided some new special benefits for the industry, including opportunity zones, a 20 percent pass-through deduction for certain types of qualified business income, and bonus depreciation for certain assets. The TCJA also lowered tax rates on both corporate and individual income, reducing tax liabilities for commercial property owners. And perhaps more importantly, the law preserved several significant benefits that already existed—notably tax-free 1031 exchanges and carried interest—that had been targeted in earlier versions of the legislation.
Winter outlook dominated by the pandemic
How might CRE fare under a Biden Administration? The most important factor will be the strength of the economy, which at least initially will depend primarily on containing the pandemic. Until COVID-19 is under control, property markets cannot revert to “normal” performance—whatever that new “normal” looks like in the future.
Fortunately, several vaccines recently have been shown to be highly effective in preventing COVID-19 symptoms, an essential step in the economic recovery, but even optimistic predictions do not anticipate widespread distribution before the spring. The Biden Administration promises a more aggressive federal response to limiting the virus’s spread and treating the afflicted but, of course, does not take office for another two months.
In the meantime, the best hope for the economy and the property sectors may be a robust stimulus package, which Biden just announced is his top priority—even prior to his inauguration. Congress has been at an impasse for months over the size and contours of this next pandemic relief bill, though a new bipartisan proposal might offer hope. Among other provisions, the bill would provide assistance to jobless workers by extending federal unemployment benefits at $300 per week for 16 weeks, and would provide additional funding for small businesses via the Paycheck Protection Program. Though there seems to be widespread support for the compromise, the White House and Senate Majority Leader have offered competing proposals offering less aid for unemployed workers, and the prospects for the passage of any stimulus package remains uncertain.
The Biden tax plan
Eventually, the virus will be contained, and consumers and businesses will get back to whatever they used to do. What then? What would the Biden plan mean for the property sector? No policies have been formally proposed, but we know much of what the administration would like to implement based on Biden’s campaign statements and speeches, though much of the detail must still be fleshed out.
And even then, much will depend on the outcome of the upcoming runoff elections in Georgia for the two undecided Senate seats. Biden can’t unilaterally enact his plans; it’s up to Congress to ratify the legislation that coverts the campaign ideas into practice. Should these seats remain in Republican hands, as conventional wisdom expects, Republicans almost certainly would retain control of the Senate, which would likely doom, or at least dilute, many of Biden’s proposals.
But for the sake of analysis, let’s review Biden’s central positions. As a candidate, Biden proposed a variety of tax policies that collectively would raise some $2.1 trillion in revenue over the next decade, according to recent analysis by the nonpartisan Tax Policy Center. Few of the provisions specifically target real estate, but some do, and others would directly impact property investors and real estate companies. Among the key proposals:
Tax rates and income classifications
Raise tax rates on corporations and high-income individuals: Biden promises to hold or reduce taxes on anyone making less than $400,000 a year, but wealthy taxpayers and corporations would pay more. Biden wants to roll back some parts of the TJCA tax cuts by increasing the corporate tax rate back up to 28 percent (from 21 percent) while individual income tax rates would revert to their pre-TCJA values for taxable incomes above $400,000, raising the top rate from 37 to 39.6 percent. In isolation, these measures would have little direct impact on property sector operations but would reduce investors’ after-tax returns.
Phase out qualified business income (QBI) deduction above $400,000 of income: The 20 percent QBI deduction authorized by the TJCA effectively lowered the top tax rate from 37 percent down to 29.6 on flow-through income for certain types of non-corporate small businesses and partnerships. Eliminating this deduction would further depress real estate returns for property investors.
Treat capital gains and dividends like ordinary income for households earning over $1 million: The Biden plan calls for “asking those making more than $1 million to pay the same rate on investment income that they do on their wages,” though many details remain sketchy. Currently, the top tax rate on long-term capital gains is 20 percent (for investors with an income of at least $441,451 in 2020), plus a net investment income tax (NITT) of 3.8 percent (for married couples filing jointly earning at least $250,000), for a total of 23.8 percent. The proposed tax increase would nearly double the tax rate to 43.4 percent for households earning more than $1 million (39.6 percent rate on ordinary income plus the 3.8 percent NITT).
The treatment of carried interest could also change. “Carried interest” is the profit share received by general partners in a fund as part of their compensation. Currently considered to be investment income by the tax code, it is thus taxed at the capital gains rate. Though the current plan does not expressly propose changing the treatment of carried interest, Biden has proposed this change in the past, and treating all investment income as ordinary income for high-income households would effectively accomplish the same objective.
If enacted, these proposals would be present a much greater hit to real estate investment returns than the relatively nominal increases in personal tax rates. The blow to private equity firms and real estate partnerships would be greater still, affecting both the investors and employees of these firms.
Eliminate the step-up basis for inherited assets: The Biden plan proposes to change the tax basis of inherited assets from the fair market value at the time of inheritance (the “stepped-up” value) to the original acquisition price before all the accrued appreciation. For example, if you inherit a property from your parents that they acquired for $1 million that is now worth $3 million, under current law your tax basis is $3 million, but Biden plans to revert the basis to the original purchase price of $1 million.
Such a change would negatively impact property values by reducing the total returns to owners. However, it is unclear whether the tax would be due in the year the asset is inherited or only upon sale. If the latter, the tax liability theoretically could be pushed to the next generation, and perhaps indefinitely, if the asset is retained and not sold.
Limiting Use of 1031 Exchanges to Households Earning Less than $400,000: Property investors may defer paying capital gains taxes on investment sales if they reinvest the proceeds into a “like-kind” property within certain time limits. Although there are no specific value limits on properties that can be exchanged, for practical reasons, the assets tend to be smaller investment properties and not larger institutional-quality assets.
Although not explicitly mentioned in the Biden tax plan language, campaign officials have alluded to restricting the use of these exchanges to households with less than $400,000 of income. The impact of this limitation could be significant, particularly in the market for smaller investment properties and vacation homes ( cannot be used for primary residences and thus would not be affected). The annual volume of 1031 exchanges is substantial but unknown as property transfers are not publicly available in every state. However, a recently updated academic study identified over $30 billion in 1031 exchanges for each of the last five years, topping out at $37.2 billion in 2019, though these figures understate the total volume in several important respects.
This same study concluded that “We conclude that elimination of real estate exchanges would likely lead to a decrease in transaction activity in most CRE markets as well as price declines in some markets, at least in the short run. These price declines would be more pronounced in states with high income tax rates. Elimination would also likely produce a decrease in capital investment on acquired properties, an increase in investment holding periods, and an increase in the use of leverage to finance acquisitions.” While the objectivity of this analysis could be questioned given its funding by the Real Estate Like-Kind Exchange Coalition, the study is widely cited, rigorous, and well documented.
Reduce the estate tax exemption and raise the estate tax rates: Biden proposes to restore the estate and gift tax rates and exemptions to their 2009 levels, increasing the top rate for the estate tax to 45 percent and reducing the exemption amount from the current $11.58 million down to $3.5 million. These changes would reduce the value of inherited assets for their new owners. As with limiting the use of 1031 exchanges, raising the estate taxes could ultimately depress asset prices though the impact on property investment levels would be less clear.
Bonus depreciation changes: The TJCA doubled the bonus depreciation deduction from 50 percent to 100 percent for eligible assets, enabling firms to immediately write-off these assets—a key benefit for real estate companies. The Biden tax plan does not specifically target this provision, but a proposed minimum 15 percent tax on the book income of large corporations could limit the value of these deductions. Moreover, this deduction will phase out starting in 2022. President Trump was proposing to extend the deduction while Biden may be less likely to. Thus, the Biden tax plan could effectively limit and eventually eliminate the bonus depreciation deduction, reducing after-tax income for real estate corporations.
Reform Opportunity Zone (OZ) program: Another key benefit in the TJCA for the property sector, the OZ program allows for tax-free capital gains for investments held at least ten years in designated areas, among other provisions. Biden seeks to reform the program to provide more community benefits. His ideas include greater transparency about investments, encourage investors to partner with community groups, and conduct a regulatory review to better target OZ funds. Biden also proposes to expand the separate New Markets Tax Credit and make it permanent, providing more opportunities and incentives for community development groups to invest in lower-income neighborhoods.
Expand renewable-energy tax credits: The commercial real estate sector could benefit from Biden’s desire to expand funding for various sustainability programs, including tax credits for carbon capture, emission reduction, and restoration of the Energy Investment Tax Credit (ITC).
After four years of business-friendly tax policies under Trump, the incoming Biden Administration is certain to be not as directly supportive. Most of the known and likely tax policies would raise taxes on both business revenue and the personal income of wealthier households, and many would change the treatments of investment income that reduces net returns. But real estate firms could also benefit from the retention or expansion of some tax policies like Opportunity Zones and the New Markets Tax Credit program, as well as renewable energy policies. The details of the new administration’s plans are obviously not set in stone but from what we have heard from them so far, there will be some sweeping changes in the tax code. All of this might be a moot point though if the administration is not able to stem the tide on the pandemic and help the economy recover from what will be almost a year of on-and-off lockdowns.