I have been a professional real estate investor since before the Great Financial Crisis and have seen just about everything: markets going up and down, trends that are fading from settling and staying and, certainly, changes in political leadership that produce new fiscal policies.
Now we have President Biden in the White House and see his proclamations and political positions. Let’s take a look at the administration’s guidance and what could happen this year with potential implications for real estate investing.
First of all, the economy at present is on fire. US GDP could exceed 6% this year, according to the Conference Board. Of course, the recovery is uneven and the Covid remains a serious factor at the global level. But I am rating macroeconomics because in my practice, we believe that there is no better indicator of potential demand for investment property. When the economy is expanding, demand generally increases for income properties occupied by commercial users and multi-family properties that provide rental housing to individuals.
Watch for changes to capital gains taxes and trade 1031
In terms of tax policy, the Biden administration now has on the table proposals that could affect investment in real estate: an increase in the capital gains tax rate and limits on the use of 1031 exchanges of the same nature. (Basically, 1031 swaps allow real estate investors to defer capital gains and other taxes on investment gains when they reinvest the proceeds in other investment property.) Biden proposed to increase the rate of 39.6% capital gains tax for people earning more than $ 1 million per year. .
My hope, shared by many others, is that the capital gains tax rate does not increase. I believe a favorable capital gains tax rate encourages just that – capital investment. But let’s say the rate goes up: how would that affect real estate investments? Generally speaking, this would potentially lower returns, but it would also lower returns on all kinds of investments, including on the sale of stocks, bonds, and other assets. So any blow to your investment real estate portfolio would not be pretty but could be proportionate.
In this environment, the reasons for a diversified portfolio of stocks, bonds and alternative investments that include real estate would be the same as today: to try to reduce risk by holding a mix of assets, including durable assets, not all of which correlate with the stock market. Real estate investment, as a reminder, does not fluctuate, as a class, with the stock market. And there is the potential to generate income (positive cash flow) in addition to potential appreciation. There are also other tax benefits associated with real estate investing, including depreciation deductions to help protect income.
Should You Sell Investment Real Estate Now?
In the short term, some real estate investors may ask, “Should I sell now to anticipate any change in the capital gains tax rate?” The simple answer is maybe. There is no one answer for everyone. It depends on your personal situation and the property you own. If its value has held up well during the pandemic and you need to sell, that may make sense. If the value has gone down but is about to rebound and you don’t need the proceeds now, it may be a good idea to wait. Of course, consult your tax or legal advisor when considering options, as everyone’s individual situation is different.
Biden also proposed to restrict the use of 1,031 exchanges of the same nature. To be clear, he did not propose to remove them, but to limit their use. In the administration’s budget published at the end of May, it is proposed to limit the amount of capital gains on the disposal of investment properties that can be carried forward to $ 500,000 per year for individuals and to $ 1 million per year. year for married couples. (Today, there is no limit on the amount of capital gains from the sale of investment property that can be protected using 1031 exchanges.)
In particular, 1,031 stock exchanges offer a multitude of advantages to the real estate market and the national economy, in particular by facilitating the redeployment of investment capital towards more productive assets. They are also very popular with landowners, including owners of family farms and owners of small rental homes and apartment buildings, to help build wealth.
DST could become even more attractive
If the use of the 1031 becomes limited, one investment vehicle that is likely to become even more attractive is the Delaware Statutory Trust (DST). DSTs are a form of fractional real estate ownership that is 1031 eligible, unlike many other real estate co-investment structures. DSTs can be a great way to invest in real estate, including an important part of a diversification strategy.
I mention them because DST interest has relatively low minimum investment amounts – typically $ 100,000 – so the corresponding earnings could be less than any new threshold that can be set to qualify for the 1031 tax treatment. , many investors own shares of more than one DST as part of a diversification strategy. Thus, if the real estate holdings of an investor are spread over several DSTs with different sales deadlines, the gains during the same year could potentially not exceed the imposed limit in order to benefit from the tax deferral treatment 1031 To learn more about DSTs and how they can be used in a 1031 exchange, visit www.kpi1031.com.
A strategy investors are now considering
Many investors are considering selling larger real estate now and exchanging 1031 for a number of Delaware Statutory Trust investments at lower prices in an effort to potentially protect themselves from 1031 exchange limitations in the future. For example, if an investor had a $ 3M property that they sold and traded for six different DST investments in $ 500,000 increments, they would potentially prepare to continue to defer earnings through 1,031 exchanges in the future. , although the limitations proposed by the Biden administration will come into effect. It’s also because each DST has its own business plan and timeline, with real estate sales likely to occur at different times and in different years in the future.
What will happen to these federal tax policy issues this year? Nothing, or something, no one knows for sure. In the meantime, investment property owners and investors should make the best decisions possible today given what we know now, recognizing that regardless of tax policy, real estate is likely to remain a class. attractive asset to many investors interested in diversification and the pursuit of income and appreciation. As always, diversification does not guarantee profit or protect against loss, and income and appreciation are never guaranteed with any investment.
This document does not constitute an offer to sell or a solicitation of an offer to buy securities. There are significant risks associated with investing in real estate securities, including illiquidity, vacancy, general market conditions and competition, lack of operating history, interest rate risks , general risks associated with owning / operating commercial and multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long holding periods. There is a risk of losing all of the invested capital. Past performance is no guarantee of future results. Potential cash flows, potential returns and potential appreciation are not guaranteed. Securities offered by Growth Capital Services, member of FINRA, SIPC, Office of Supervisory Jurisdiction located at 582 Market Street, Suite 300, San Francisco, CA 94104.
Founder and CEO, Kay Properties and Investments, LLC
Dwight Kay is the Founder and CEO of Kay Properties and Investments LLC. Kay Properties is a 1031 national exchange investment company. Www.kpi1031.com platform provides market access to 1031 exchange properties, 1031 custom exchange properties only available to Kay clients, independent advice on sponsor companies, due diligence and verification of each 1031 exchange offer (typically 20 to 40 offers) and a secondary market of 1031.