The second half of President Biden’s infrastructure agenda has significant tax implications for the rental housing industry.
On April 28, President Biden unveiled the second half of his infrastructure agenda, the American Families Plan. Released just weeks after the American Jobs Plan, this new proposal is focused on providing educational, child care, family and workplace benefits. Notably, the $1.8 trillion proposal would be financed by significant tax increases that would directly affect the multifamily industry. As outlined below, the proposal would impose steep increases on tax rates and capital gains while eliminating carried interest, curtailing like-kind exchanges and repealing stepped-up basis.
State of Play
Prospects for enacting the American Families Plan are uncertain. Some Democratic members of Congress would like to see the proposal processed alongside the Administration’s previously released $2.25 trillion American Jobs Plan that is focused on traditional infrastructure. However, others would like to first pass a traditional infrastructure package in a bipartisan manner before moving to a second proposal.
Additionally, it is unclear that all Democrats would support the Administration’s proposed tax increases, which Republicans are likely to unilaterally oppose. With their narrow majorities, Democrats will have little margin in the House and no margin in the Senate to approve extraordinarily significant revenue increases. Given this political reality, many of the Administration’s proposals may need to be modified to win approval or will end up being dropped. As Congress moves forward, NMHC and NAA will continue to educate policymakers about the key role these tax provisions play in the multifamily industry.
Analysis of Proposals
Following is an exploration of the key proposals in the American Families Plan that would impact the rental housing industry.
Ordinary income
Individuals pay ordinary income taxes at rates of up to 37% as they earn wages. The Biden Administration seeks to increase the top marginal rate to 39.6%.
Capital Gains Taxes & Carried Interest
Multifamily taxpayers often face capital gains taxes when they sell properties. While the maximum capital gains tax rate for assets held over one year is currently 20%, the Biden Administration is proposing several changes to the taxation of capital income.
Capital Gains Tax Rate: The Biden Administration would raise the top capital gains rate to 39.6% for taxpayers earning over $1 million. Since 1991, capital gains have been appropriately taxed at lower rates than ordinary income as they are derived from investments in capital assets and entail risk.
Carried Interest: The Biden Administration would tax carried interest at ordinary income tax rates as opposed to capital gains tax rates under present law. Carried interest should receive capital gains tax treatment because it represents a return on an underlying, long-term capital asset, as well as risk and entrepreneurial activity. This is in contrast to any fees that managing partners receive in payment for operations and management activities, which are taxed as ordinary income. A higher tax rate on long-term capital gains will discourage real estate partnerships from investing in new construction at a time when demand for apartments continues to grow and chronic underbuilding has limited new housing supply.
Medicare Surtax: Under current law, taxpayers are assessed a 3.8% Medicare tax on net investment income above $200,000 for single filers and $250,000 for joint filers. The Biden Administration believes “application is inconsistent across taxpayers due to holes in the law.” It seeks to “apply the taxes consistently to those making over $400,000 per year.” The implications of the proposal are unclear, but the National Apartment Association (NAA) and National Multifamily Housing Council (NMHC) would strongly oppose imposing the 3.8% net investment income tax on capital income derived from a trade or business that is not passive.
Like-Kind Exchanges
The Biden Administration proposes to eliminate like-kind exchanges for gains exceeding $500,000. Like-kind exchange rules play a crucial role in supporting the multifamily housing sector by encouraging investors to remain invested in real estate while still allowing them to balance their investments to shift resources to more productive properties, change geographic location or diversify or consolidate holdings. Like-kind exchanges enable property owners to defer capital gains tax if, instead of selling their property, they exchange it for another comparable property. As long as the taxpayer remains invested in real estate, tax on any gain is deferred. When the taxpayer ultimately does sell the asset, the property tax is paid.
Stepped-Up Basis
The Biden Administration proposes to eliminate stepped-up basis and tax unrealized capital gains at death. There would be a $2.5 million exclusion per couple taking into account existing rules benefiting the sale of principal residences. Additional rules would also enable tax deferral to the degree heirs continue to run family-owned businesses.
If enacted, this proposal would have extremely unfortunate consequences. Not only would death become a taxable event at $2.5 million, a level far below today’s estate tax exclusion, but tax could also be imposed even before the asset is sold. If tax is imposed immediately upon transfer, in many cases, those inheriting property might not have the cash to pay the tax due. Even if the funds to pay the tax are available, little might be left over to improve and upgrade the property, which could negatively impact the amount of affordable housing in the marketplace.
Excess Business Losses
The Biden Administration seeks to make permanent a provision limiting excess business losses. A non-corporate taxpayer has an excess business loss to the degree that total business deductions exceed business income, plus $250,000 for single filers and $500,000 for joint filers. This provision is part of current law but set to expire at the end of 2026.