Many of you have been anxiously awaiting this information for several months and it is finally here. We now have a better understanding of what the proposed tax policy and proposed changes might look like.

According to Accounting Today:

“The biggest tax hike in a generation took a big step forward with proposals worth $2.1 trillion in potential tax levies.”

While these proposed tax changes are primarily aimed at corporations and the wealthy, it also includes some items that could also have a significant impact on everyday real estate investors. Before we get into the details, here are some important things to keep in mind.

First, these are just suggested tax changes. None of these have yet been signed into law. Many of these proposals are subject to change and some may not even come through, so don’t make any hasty decisions without talking to your team of advisors first.

Subsequently, tax changes affect different real estate investors in different ways. For example, if tax rates rise, it does not mean that your taxes go up automatically. What consequences a change may have for you depends on your overall financial situation. So again, talk to your advisors before taking any action.

Now you may be wondering, if these are all just proposals that may or may not come true, why bother investigating them now? Well, the reason is that you need to be proactive in order to successfully maximize your tax savings. That means making informed decisions based on all the information currently available to you. Depending on when these tax changes happen, there may be limited time to make some important decisions. You don’t want to wait until the last minute to even start the process. Also keep in mind that taxes don’t have to be scary. And to be fair, the information we now know as part of the proposed tax changes isn’t all bad news. There is some good, some bad and some ugly.

Self-directed investments in retirement accounts

Many real estate investors have used retirement money to invest in real estate rather than the stock market. Self-directed investing allows investors to put their retirement money into various types of real estate deals without paying current taxes or penalties. Some of the popular vehicles that attract real estate investors are bank notes, rental properties, and syndications, just to name a few. The proposed legislation could prohibit individual retirement accounts (IRAs) from holding private equity, debt securities and other investments that require the IRA owner to meet certain financial, educational or licensing requirements.

So, who does this affect? If you’re using your self-directed IRA to invest in a syndicated deal that requires the investor to be accredited, this proposed tax change could be problematic for you. The new proposed law, if passed, would require the IRA to dispose of (or remove it from the retirement account) the interest by December 31, 2023. If not done correctly or in a timely manner, you could be subject to potential taxes and even fines in excess of 50%. If this proposal is passed, it may no longer be a viable option in the future to use self-directed money in most real estate syndicate investments.

Another part of the proposal would prohibit the IRA from owning more than 10% of an investment or entity, and the proposal would also prevent the IRA from investing in an entity in which the IRA owner is an officer (regardless of ownership percentage). This means that commonly used strategies such as Checkbook IRA LLCs, trusts, blocker corporations, and joint ventures (JV) may no longer be allowed for IRA investments. For example, your IRA may no longer be able to invest as a joint venture in a 50/50 deal with another person.

However, here’s the good news: you can make your voice heard. Contact your representatives and senators and ask them to vote against this proposed tax change! If you want to make your voice heard, but don’t know where to start, we’ve put together some for you information to help you with that.

Tax rate changes

Possible increases in tax rates, we’ve been hearing about that for months. No big shock here. The highest federal income tax rate can rise from 37% to 39.6%. The highest tax rate applies to single taxpayers with taxable income over $400,000. However, as a married couple, the highest tax rate kicks in when the joint taxable income is over $450,000. As you can see, there is a heavy tax penalty for married taxpayers. The proposal not only raises tax rates, but also lowers the income level at which the higher tax rates take effect. This means that more people could pay at the higher rates and a larger portion of their income could be taxed at these rates. Why is it important for us to look at ordinary tax rates? When it comes to real estate, many types of income are taxed at normal rates. Rental income, property management income, flip income, wholesale income, commission income, and interest income are some examples of real estate income that is typically taxed at normal rates.

Another proposed change to the tax rates that we expected is with regard to C corporations. While the proposal states that the top tax rate for C-corp could increase from 21% to 26.5%, it only affects C-corps with incomes over $5 million. For the average real estate investor who uses C-corps to make a profit or profit from property management, the proposal would reduce the C-corp tax rate to 18% on the first $400,000 of taxable income. This would be a welcome tax break if passed.

Capital Gains Tax

As investors, many of us have been anxiously awaiting details on any proposed changes to capital gains taxes. The somewhat good news here is that instead of raising it to the previously discussed 39.6%, the current proposal would raise capital tax rates from 20% to 25% for higher-income taxpayers. A quirky part of the proposal is that the higher rate of capital gains tax would apply to gains made on or after September 13, 2021. This means that if you sold assets before this date, you will see the current lower price gains. Alternatively, if you have sold certain assets after that date, the proposed higher tax rate may take effect.

The proposal does include a transition period for transactions entered into before September 13, 2021. An example could be when an investor enters into a sale agreement in August 2021 but closes the sale after September 13, 2021. They would still pay the lower capital gains tax. Common examples of capital gains include the sale of a rental home, the sale of a primary home, the sale of stock, and the sale of business assets, to name a few.

New corporate income taxes

Another proposed change is that higher-income taxpayers with ordinary business income will be subject to the net income tax. Historically, this tax was only levied on: investment income for high-income taxpayers. Now the proposal also wants to assess this for the first time on the basis of company income. This would be an additional 3.8% tax on top of the federal and state income taxes you already pay. For example, common types of ordinary income from a real estate trade or business can include property management income, flip profit, wholesale income, commission income, and wealth management income. This can affect single taxpayers with taxable income over $400,000 and married taxpayers with taxable income over $500,000.

Roth retirement accounts

Current law allows all taxpayers to convert money from a traditional IRA into a Roth IRA so that the money can grow tax-free in the future. This applies regardless of the taxpayer’s income level. The recent proposal would remove that for single taxpayers with taxable income over $400,000 and married joint taxpayers with taxable income over $450K. This means that if assumed, higher-income taxpayers may no longer be able to use the backdoor Roth or mega backdoor Roth strategy with their IRA or 401Ks.

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Any good news?

Actually, yes, there seems to be some good news for real estate investors. The good news revolves around what we not done see in the proposed tax changes. For over a year now, we’ve been hearing about the potential elimination or limitation of the popular 1031 trade advantage. Here, an investor can sell valued rental properties and replace them with another property and defer the associated taxes. There was no mention of 1031 exchange in the latest tax proposal, so we believe that no news is good news.

Many investors are also concerned about whether the tax breaks for real estate professional status, bonus write-offs and any general corporate write-offs will be eliminated. As with the above, we have not seen the ones mentioned in the proposed tax changes. Again, for now, no news is good news.

So what now?

The first step is to step back and take a deep breath. These are currently only suggested tax changes, not the law. It doesn’t mean that the government takes everything you have. Tax laws change from time to time, and that just means changing some of your tax strategies and investment decisions. As new tax laws are introduced, new strategies are developed. The best thing you can do now is understand how these potential tax changes can influence your tax plan and investment decisions. The second step is to keep your line of communication with your team of advisors open so they can help you prepare for any actual tax changes in the coming months. And of course the third step is to make your voice heard on these proposals!

If you’re looking for a way to jump-start your tax savings, check out the Boot your tax savings mini-course on request. BP Pro members receive a 50% discount using the coupon code found in the member benefits section.

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