Biden Has Proposed Sweeping Tax Changes. Here’s What One Analyst Thinks Will Really Happen

With the American Jobs Plan and the American Family Plan, the Biden Administration has laid out ambitious programs to tackle infrastructure and social issues. To pay for this $4.5 trillion expenditure, the administration plans to implement tax increases. 

At face value, for commercial real estate investors the tax proposals are alarming. But a closer look can ease some of the fears in the community.

Carried Interest 

For example, the administration has proposed reforming or eliminating the current tax treatment of carried interest.

However, Cushman & Wakefield’s David Bitner, global head of capital markets research insights, thinks it is unlikely that this happens. While carried interest has been rumored to be on the chopping block, this move may not have a significant impact. Bitner cites a Moody’s Analytics estimate that taxing carried interest as ordinary income would only raise an additional $14 billion over ten years. In addition, Bitner writes that “a concentrated and well-organized interest group with significant influence in both Republican and Democratic party politics” favors carried interest.

With these forces lined up against changing carried interest policy, Bitner urges investors not to lose sleep over any potential change. If these proposed changes become a reality, Bitner thinks closed-end funds could experience internal pressure to accelerate realization in 2021. However, that will be only marginal given the liquidation profile of most funds. He says limited partners should be aware of this principal-agent problem. Though it is likely to be difficult, he says fund managers should think about alternative incentive structuring for future funds and even existing fund vehicles.

Capital Gains 

Capital gains is another target with a potential increase of 20% to 39.6% for households reporting income over $1 million. However, Bitner predicts that this tax increase will eventually land at 28%.

Since the tax could hit democratic constituencies, he predicts resistance from moderate Democrats and representatives of affluent districts. With a slim margin in Congress, these groups should be able to get concessions.

Like with carried interest, there are questions about how much revenue capital gains tax increases will generate. Bitner estimates $113 billion to $448 billion over the 2022 to 2031 forecast period.

Bitner thinks investors will have some incentive to sell before these changes occur, though he believes it’s likely that the change will happen in the 2022 tax year. He says these changes may make a sale more attractive to investors already considering dispositions. In addition, long-term holders with gains not yet realized may also consider selling if they do not believe market conditions are distinctly unfavorable.  If investors don’t fall into these categories, they should operate as usual and build a larger margin of safety into underwriting.

Some experts think qualified Opportunity Zone investments may be able to hedge some relief for capital gains tax increases.

The Opportunity Zone program was part of the 2017 Tax Cuts and Jobs Act. The intent was to create an incentive for long-term investment in designated low-income communities.

“In order to be eligible for the tax benefits, an investor needs to have eligible capital gains,” Jessica Millett, partner and chair of the tax department at NYC real estate-focused law firm Duval & Stachenfeld, tells GlobeSt.com. “Ordinary income doesn’t count.” And the OZ program “doesn’t seem to be on the chopping block,” she adds.