I am always amazed at how out of touch our elected officials are with what happens in the real world. The new tax plan circulating through Congress is no exception with the supposed target high net worth taxpayers, but middle class, small business owners, farmers, and rural property owners will get hit the hardest. If you or your parents own real estate you are in for a huge surprise and not a good one! What is in the new tax proposal? How will the new tax plan eliminate a considerable amount of open space in Colorado?
What is in the new tax proposal?
There are a number of items in the proposed tax bill including payroll tax increases, increase in corporate taxes, increased in capital gains tax, etc.. but for this article I want to focus on the provisions that will impact real estate the most. The three major impacts to real estate are the elimination of the stepped up basis, taxes being paid on transfer, and a drop on the estate tax exemption.
Eliminate the stepped-up basis:
- A step-up in basis reflects the changed value of an inherited asset. For example, an investor purchasing shares at $2 and leaving them to an heir when the shares are $15 means the shares receive a step-up in basis, making the cost basis for the shares the current market price of $15. Any capital gains tax paid in the future will be based on the $15 cost basis, not on the original purchase price of $2.
- The new tax proposal eliminates stepped up basis: For example now if you inherit a property that your parents bought for 100k, that is now worth 1m, your tax is now based on the 100k so your gain is 900k that you would pay taxes on.
Tax gains at transfer:
- Currently: you pay taxes when the asset is sold not when transferred
- The new tax proposal would make death a “transfer” and taxable For example in the past if you inherited a house you would only pay the capital gains when you sold the house, now you are responsible for the capital gains as soon as the death occurs whether you hold or sell the house doesn’t matter
Drop estate tax exemption:
- Currently: the estate tax limit, i.e., death tax exemption, is up to 12 million
- The new tax proposal cuts the deduction to 5 million.
Who does the proposed tax law effect the most?
The current administration continues to emphasize that this new tax bill will only affect the highest earners, unfortunately this couldn’t be farther from the truth, the impact will be felt primarily by the middle class and property owners regardless of their wealth.
- Farmers/ Ranchers/ Rural property owners: Farmers are typically asset rich and cash poor. Farming and Ranching are very capital-intensive activities with the majority of their wealth tied up in land. For example, a rancher could have inherited 1500 acres that they use to graze cattle on. When the owner passes away and the asset is transferred to the next generation a huge taxable event occurs. Here is a quick example: assume the land has been in the family for 50 years, the basis on the land is pretty close to zero so the tax due would be enormous. The land is now worth 5k/acre, so a total value of 7.5m. Under the new law the max deduction is 5 million that leaves 2.5million taxable at long term capital gains rates. The heir would be on the hook for 500k now. In the ranching business, I doubt they have 500k lying around to pay taxes!
- Small business owners: Similar to Ranchers, many small business owners have substantial assets tied up in their business that are not liquid. For example, a family-owned roofing company could have numerous trucks, forklifts, cranes, etc… When the business transfers to the next generation taxes are now due and payable which creates huge liquidity issues for the heirs and will force a sale of many small businesses.
- Middle class: On the surface a 5 million estate tax exemption seems huge, but with the elimination of a stepped-up basis it is not hard to easily hit this cap as assets and businesses have appreciated over many years. Take for example a person has been acquiring residential rental properties or a small apartment complex. With the historical appreciation and recent run up in real estate, the heirs could be looking at an enormous tax bill without the liquidity to pay.
How does the Biden tax proposal eliminate open space in Colorado?
The real crux of the proposed tax law is that it puts owners of non liquid assets like ranches, farms, large acreages in a precarious situation. The tax hit, with the elimination of the stepped up basis along with making death, not a sale as in the past, will be the trigger for taxes will force millions of acres to be sold.
The heirs of these large acreages will not have the cash to pay the taxes and therefore will sell the properties to the highest bidder. Many of these properties will be split up to enable a sale. For example, there are not that many buyers of 1500 acre ranches, but there are considerably more buyers of 40 acre or 5 acre parcels. The way the current tax proposal is written will have enormous consequences with the loss of working farms and large acreages that are critical and will never be replaced.
Summary
The new law will not bring in nearly the revenue as stated as ultra-wealthy like Jeff Bezos have employed generational skipping trust and other extensive tax planning to avoid the tax hit. The real losers in this bill are Farmers, rural property owners, small business owners, and the middle class that do not have the resources for extensive estate planning. There is no free lunch in economics, although our elected officials continue to tout that it will not impact “average Americans” which couldn’t be farther from the truth as small business owners, ranchers, farmers, and countless others are forced to sell their properties/business to pay for the tax plan. Unfortunately, our elected officials are highlighting once again how out of touch they are with the impacts of their policies.
Additional Reading/Resources
- https://www.bloomberg.com/news/articles/2021-03-22/biden-determined-to-tax-rich-after-windfalls-from-covid-crisis?srnd=premium
- https://www.cnbc.com/2020/03/13/this-is-how-joe-biden-will-tax-generational-wealth-transfer.html
- https://www.investopedia.com/explaining-biden-s-tax-plan-5080766
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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