Behind President Joe Biden’s ambitious stimulus proposals are the question of how to pay for them. The proposals seek to answer that question through a series of tax increases that would effectively undo many of the lower rates enacted by Congress in 2017.
In a recent Marcus & Millichap webcast titled “Tax Reform: A CRE Game Changer?,” CEO Hessam Nadji noted that provisions of particular concern to the firm’s clients, many commercial real estate investors, and the industry as a whole are the increase in the top-tier income tax rate to 39.6%, the increase in the capital gains tax rate, the institution of a $500,000 cap for the 1031 exchange, elimination of the step-up basis for gains of $1 million or more, and the taxation of carried interest for investments and developments at the same rate as ordinary income.
Nadji and his panelists—Jeffrey DeBoer, president, and CEO of the Real Estate Roundtable; and Lisa Knee, partner with EisnerAmper—emphasized that these proposals are just that. They haven’t manifested as actual legislation as yet, although Knee pointed out that a bill related to carried interest is being discussed in the Senate. However, DeBoer said, “This is a proposal from a President of the United States to a Congress that is controlled by his party. So it’s a very serious proposal and should be taken that way.”
Moreover, Nadji pointed out, proposals to change key tax provisions generally occur one or two at a time. “In this particular window of time, we’re looking at a combination of things happening all at once,” he said.
DeBoer said major CRE industry associations such as the Roundtable are mobilizing to educate lawmakers on the potential impact these changes could have if enacted. He noted that groups such as the Nature Conservancy also are potentially affected by a curtailment of the century-old 1031 provision, as are minority- and women-owned businesses.
It’s a point, DeBoer said, that should be driven home to lawmakers by every participant in the webcast, which was one of Marcus & Millichap’s best-attended this year with more than 15,000 investors registered.
He said the industry isn’t shying away from the prospect of government revenue increases or the need to increase taxes to finance certain programs. “However, we’re very concerned about targeting certain industries and what I would call the unintended impact of some of these proposals,” DeBoer said.
The sum total of these tax-reform proposals, if enacted, could be “locking people into their investments, deter properties from moving to their highest and best use and deterring capital improvements into properties.”
He added, “We’re not saying that the tax laws are perfect. But now is not the time to impede risk capital investment, impede transactions and slow down the economy.”
The webcast experts agreed that the provisions that are ultimately enacted may or may not resemble what has been proposed, and this makes it a challenge to predict what the actual impacts will be. Knee advised that the best course investors and their advisors can take is to model cash flow projections for the next few years under current laws and under any proposed changes.
In addition, Knee advised “making sure your decisions are based on the overall economics of the deal. Everyone focuses on taxes; you still have to look to see if the deal makes sense.”
On the question of where the capital gains tax rate could end up, Knee demurred, saying that EisnerAmper bases its tax advice on the current laws. “We do know that historically there have been periods where the capital gains rate is higher than it is today,” she said.
She noted that aside from the actual changes to the tax code, another concern is when such changes if enacted, would take effect and whether this would affect transactions that people are working on now. Knee noted that generally, these laws become effective as of the date when they were enacted or introduced to Congress, and at present, there is no legislation under consideration, so it may be an opportune time for sellers and investors to act.
Nadji asked DeBoer whether a 28-30% range represents the outer edge of the break-even point on capital gains. “The common view is that if the rate starts to dip below 20%, you’re getting diminishing returns,” DeBoer said. “You start with why we have a capital gains rate that is lower than ordinary income—we’re trying to encourage and incent risk capital to make investments that will create jobs and propel the economy forward.”
The other side of the coin is how low the rate can go before there’s no more incentive. “There’s no magic rate here, but there certainly needs to be a differential that will encourage that capital,” said DeBoer.
Responding to numerous audience questions, DeBoer said that in theory, assuming the Democratic majority in the House simply wanted to enact the President’s proposal, the tax reform agenda could be a done deal by July 1. However, that represents a “highly unlikely” scenario, he said.
More likely is that Biden will continue reaching out to Republicans to get bipartisan agreement on the infrastructure package, based on what is historically defined as infrastructure, and then come back and work on the “human capital” items, such as child care and elder care, as well as other components of what currently represent far-reaching stimulus packages. Under that scenario, legislation could be enacted by late September or early October.