Joe Biden has called for the increase of long term capital gains taxes to be retroactive to April 28th, 2021. The changes would approximately double the top rate from 28.8% to 43.4% (including the net investment income tax of 3.8%). Before you start thinking that you would never end up in the top bracket, keep in mind that not just your personal income is used in determining your capital gains tax bracket. A sale of appreciated property can quickly move you up in the brackets. Add in state capital gains rates and you can find yourself paying 56.7% if you live in California. Washington State has a new capital gains tax but so far it does not apply to residential real estate.
Excluding the net investment income tax of 3.8%, the new long term capital gains tax brackets will be as follows, if married, filing jointly:
10% for an income of $0-19,750 ($0-$9,950 if single)
12% for an income of $19,751-$80,250 ($9,951-$40,525 if single)
22% for an income of $80,251-$171,050 ($40,526-$86,375 if single)
24% for an income of $171,051-$326,600 ($86,376-$164,925 if single)
32% for an income of $326,601-$414,700 ($164,926-$209,425 if single)
35% for an income of $414,701-$622,050 ($209,426-$523,600 if single)
37% for an income of $622,051+ ($523,601+ if single)
Short term capital gains are treated as ordinary income. Ordinary income tax rates will also increase.
The retroactive nature of the long term capital gains taxes was alluded to earlier:
It is possible that this is just a bargaining position. Retroactive tax increases are extremely rare. They are unscrupulous and make taxpayers angry.
But the government has been and is planning on spending a lot of money. Biden has proposed a record $6 trillion budget for 2022. In 2022, the debt is expected to be 26.3 trillion, above the expected GDP of 23.5 trillion.
This threat of retroactivity prevents investors from much tax planning. I suppose it is possible to avoid any further selling of real estate this year to be able to stay in the lower ones of the new tax brackets, but then what if the new rates don’t actually end up being retroactive? I’m getting angry and frustrated myself.
While some investors may consider 1031 exchanges, to delay payment of long term capital gains income taxes until there is a new administration that hopefully reduces taxes, be aware that there is a cost to 1031 exchanges. Besides the fees of the facilitator, you lose out on the ability to fully depreciate the new building. For example, if you sold a property that you held for 20 years, and exchange it into a new property of equal value, you continue the depreciation schedule of the old building for another 7.5 years. On the other hand, if you sold the old property and buy a new one, you get 27.5 years of depreciation deductions based on the cost of the new building. In other words, with a 1031 exchange, you are losing out on depreciation deductions in exchange for a mere delay in when you pay taxes on the property you sold. If capital gains tax rates do, in fact, go back down with a new administration, or if your income and capital gains in future will go down such that you will be in a lower bracket, it may be a good gamble. If they don’t, you may end up being worse off by doing a 1031 exchange. I’m not a tax expert but you can see how you need one (as well as a crystal ball) to help you decide if a 1031 exchange really makes sense or not.