Bison Alert! – Washington DC Tax Proposal | Bison Financial Group

Bison Financial Group principal, David Repka, was recently alerted by a colleague of the newly proposed tax plan coming out of Washington, DC in October 2021 and had the following takeaways....

W A S H I N G T O N - N E W S - A L E R T

The attached article from the 10-26-21 WSJ discusses a plan circulating in Congress that will significantly increase taxes for real estate investors in three key ways:

  1. Increase in ordinary income tax rate
  2. Increase in capital gains tax rate and 
  3. Eliminate the century-old tradition of a step up in basis when the owner dies

If the bill is passed in its present form the effect on real estate will be significant including: 

  1. Reducing investment capital available to make new purchases 
  2. Owners will have less after tax cash flow to reinvest in real estate
  3. Less after tax cash flow means a buyer will need a higher cap rate to get the same after tax return on investment in 2022 as they got in 2021. 
  4. Higher cap rate means lower values. 

Eliminating the step up in basis for estate taxes at death will result in forced real estate sales and a significantly reduced cash flow after sale to the heirs. If the property was owned for many years and refinanced multiple times the taxes owed at death could exceed the equity realized from a sale (Phantom Income). This is a big potential problem for heirs! Forced sales historically lower price/value especially where multiple heirs "want their money".

The article does not discuss eliminating or changing the 1031 exchange rules which in early versions capped the amount that can be deferred by a 1031 at $500,000.
If that is added to the mix there could be additional repercussions including: 

  1. Severely lowering the amount of cash available for reinvestment in real estate
  2. Eliminating a group of buyers that have helped stabilize real estate values as cap rates compressed and real estate values increased
  3. Cap rate expansion resulting in lower property values

Couple the above with anticipated rising interest rates over the next few years and you have a toxic brew of factors to drive down the prices of investment real estate.
The only offset would be inflationary increases in rents at % rent increases high enough to offset some of the above factors. 

Conclusions:

  1. Meet with your key professionals to strategize - The principals at Bison Financial Group have been a part of $2 billion in commercial real estate transactions since 1994
  2. Refinance your income-producing real estate while interest rates are still near historic lows and values are at historic highs - cash will be king if the above scenario even partially comes true  
  3. Where possible, shift the burden of paying expenses to tenants by moving rents to NNN with no caps on property taxes if property sold. Inflation will make expenses rise faster than  gross rent leases will increase. Tenants are more willing to pay CAM increases than rent increases as they know the extra $$ isn't going to the landlord

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