CRE Investors, Developers See Risk Everywhere In Biden Tax Proposal
Commercial real estate developers and investors hit the panic button Wednesday after President Joe Biden introduced a $1.8 trillion tax-and-spend plan that offsets its price tag by relying heavily on taxing commercial real estate transactions.
Biden's American Families Plan proposes an end to tax breaks received as part of 1031 exchanges (or in-kind real estate transactions) when capital gains from those deals go beyond the $500K mark. Under the current 1031 paradigm, investors are allowed to defer capital gains on property sales by immediately pouring their proceeds into acquiring other properties.
Biden's plan also would tax people making more than $1M at a 39.6% rate on all income. If the plan passes as-is, the effective rate for people making more than $1M — as many top-tier commercial real estate people do — would effectively double, tax experts say.
"Generally, under current law, a long-term capital gain would be taxed at a top marginal rate of 23.8% at the federal level while under the proposal, a long-term capital gain could face a top marginal tax rate of 43.4% when factoring in the Net Investment Income Tax of 3.8%," said Erica York, an economist with the Tax Foundation's Center for Federal Tax Policy.
Biden's proposal still has to go before Congress and may not pass or may be significantly tweaked.
Developers who put hundreds of millions of dollars at risk every time they buy, redevelop or break ground on real estate expressed fears the proposal in its current state will create a bunker mentality in CRE, stalling new developments and transactions.
Dallas developer Artemio De La Vega with De La Vega Development expressed similar fears and noted he has enough hurdles now building in a market recovering from the coronavirus pandemic — his The Central mixed-use project is under construction in Downtown Dallas.
His development shop is considered a small business, and he said an end to 1031 exchanges and a doubled capital gains tax would push him onto the sidelines temporarily.
"I know on the capital gains part of it, we are going to limit our transactions," De La Vega said. "We are not going to go out and do any transactions because we are not willing to pay twice the amount of taxes. We are not prepared to pay twice. We just can't afford it. If we are going to stop transacting, then my best guess is other people will do the same."
As for CRE deals in the making, De La Vega is waiting with bated breath to see how much of the plan sticks in Congress and whether it passes.
"I have a couple of deals right now that are in the fire," he said. "I would be motivated to do away with those deals and not move forward because of the 1031 and the new changes."
Biden's plan could strike down overall transactional activity, and then real estate prices and cap rates also could suffer, KE Andrews' Tony Trahan said. Trahan's tax firm has been fielding calls from worried real estate investors and property owners since Biden's tax proposals came to light in 2020.
"The largest thing about it is it's going to kill activity, and it's going to drive down prices," Trahan said. "[If] there's less capital, there's less liquidity in the market because there are not as many sales. So you would have folks who are wanting to sell an office building or a piece of land that don't have an incentive to place it somewhere."
At the same time, you would have fewer buyers, Trahan said, as the market adjusts to a new normal.
But it's important to remember the Biden tax plan is just a proposal at this point and does include some positive incentives for multifamily developers, experts with the National Multifamily Housing Council told Bisnow.
NMHC supports Biden's identification of another $213B in funds to address affordable housing issues, NMHC Senior Vice President of Government Affairs Cindy Chetti said.
"We have been a long-term supporter of additional funding for housing in general," Chetti said. "[There was] $40B in new housing dollars in the March stimulus. Now, he is talking about another $213B. I have been working in this business for a long time, and these are historic numbers."
NMHC does warn termination of the 1031 exchange could impact liquidity and affordability in the multifamily space.
"It would really put a big dent in that incentive for multifamily operators and developers," NMHC Vice President of Tax Matthew Berger said of the 1031 exchange termination.
"I think the issue here is people use like-kind exchanges to reposition assets, but after they do so, they tend to reinvest capital into those assets and we have a huge housing affordability crisis right now. So, No. 1, you want to keep housing in stock and not lose it and keep people investing in it."
But Berger and Chetti see the president's plan as merely a rough draft and one that could easily change as it reaches Congress. NMHC continues working with the Biden administration to identify the best proposals for fueling housing affordability and access across the country.
Hunton Andrews Kurth attorney and partner J.R. England also is not hitting the panic button just yet.
"It's a wish list of what I'll call low-hanging fruit, which is that it's always easier to tax the rich," England said. "I don't feel as negative about it because I don't think it's going to actually be a reality. There is only so much you can do through budget reconciliation. I personally think Biden is being relatively pragmatic, and he put this out as the first shot across the bow, and it's going to get significantly reduced from that point."
England said the biggest impact would be the end of 1031 exchanges, but he's not as panicked about the capital gains tax fears.
"Do I think there will be some form of capital gains increases that will apply to people making more than $1M? Yes," England said. "Do I think it's going to be upwards of going from 20% to 43%? No. I would guess it falls somewhere in the 28 and 29% range."