Biden's Proposed Tax Hikes Could Hit CRE Retroactively

Real estate investors who are still reeling from a series of proposed capital gains taxes and a possible end to exemptions on most 1031 exchange transactions now have to worry about whether there's time to plan before the changes hit.

President Joe Biden introduced a $1.8 trillion spending package last week that includes a series of tax policy adjustments that could dramatically impact professionals involved in commercial real estate transactions.

Though the changes — including raising the effective tax rate on high earners, ending tax breaks on carried interest and reducing the benefits of the 1031 exchange program — could be tweaked or killed by Congress, CRE is trying to prepare for the potential new reality. But there may not be time to safeguard investments or close deals out before they take effect. Experts say the impact of Biden's plan depends on the official enactment date of the various taxes.

"Sometimes effective dates are set to the date of introduction, but currently there are lots of questions about whether certain tax changes might be made retroactive to deter tax avoidance strategies. It’s really wait-and-see at this point, what makes it through Congress and what effective date they settle on," said Erica York, an economist with the Tax Foundation’s Center for Federal Tax Policy.

Generally, taxes are prospective in nature and go into effect a year or two after passage, KE Andrews property tax consultant Tony Trahan said. Former President Donald Trump's tax changes outlined in the Tax Cuts and Jobs Act of 2017 went into effect the year after their passage.

But there is a strong precedent to apply these hikes to the 2021 tax year if Biden wants to begin collecting money, Trahan said. The Economic Growth and Tax Relief Reconciliation Act of 2001, known as the Bush tax cuts, was applied retroactively — it passed in June 2001 and was effective for 2001. Likewise, the IRS Restructuring and Reform Act of 1998 was signed in July 1998, and its first effective year was 1998, Trahan said.

"So there are cases, but it can be more difficult to pass," Trahan said.

Dallas developer Artemio De La Vega said that if developers and investors discover the taxes are retroactive, they may step away from deals this year, stalling the market. De La Vega told Bisnow earlier this week that if Biden's proposals go into effect, he will pause his deal activity.

On the other hand, if the proposals pass and take effect in 2022 or beyond, we could see a rush of deals this year. Trahan said if the enactment dates are at least somewhat delayed, he could see players in real estate or those impacted by capital gains changes adjusting their strategies midyear.

"If they gave us a year before they were going to implement this, you could see a flurry of activity of folks just trying to dispose of assets, closing funds and maybe buying assets for kind of the short term," he said.

"What would be interesting, too, is you might see some of the institutional groups and REITs set up funds to where there is a four- or five-year hold on them."

The idea behind these holds would be a proactive decision to wait for a different administration or Congress to reverse some of the pressures added from these new taxes, Trahan said.

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