Taxes, like life, can be like riding a roller coaster. Sometimes it’s up and sometimes it’s down. This is definitely the case when speaking about the Federal capital gains rate for individuals. In the past 20 years, this tax has been as high as 28% and is currently at its low point of 15%. But, this too shall change as of January 1, 2011, when the rate is scheduled to go back to 20%.

As part of the 1986 Tax Reform Act, the capital gains tax rate was raised from 20% to 28%. President Clinton reduced the capital gains tax from 28% to 20% in 1997. In 2003, the Bush administration passed The Jobs and Growth Reconciliation Tax Act of 2003, which lowered the capital gains tax from 20% to 15%. This reduction was due to sunset on December 31, 2008. But, in May of 2006, Congress passed and the President signed H.R. 4297, which extended this reduction in capital gains until December 31, 2010.

To complicate matters further, the Health Care and Education Affordability Reconciliation Act of 2010 was signed by President Obama on March 30, 2010, and it includes a number of revenue-raising provisions. One of these provisions, impacting high income individuals, is a 3.8% tax increase starting in 2013 on any unearned income. Gain from the sale of real estate falls within this category.

If Congress takes no action on the existing tax rates, the maximum capital gains tax rate will increase from the current 15% level to 20% in 2011 and then to 23.8% in 2013. This would be the highest rate for long-term capital gains since 1997.  No matter what the tax, it can be deferred by completing a 1031 tax-deferred exchange. Contact your local First American Exchange office for more information. 

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Possible Increase in the Carried Interest Tax

The U.S. House of Representatives recently voted to pass H.R. 4213, which, effective January 1, 2011, will increase the tax on carried interest.

What is "carried interest" and how does it affect the real estate industry? It is common for developers in the home building industry to use partnerships and other pass-through entities to organize home builders and subcontractors for their projects. In this role, the developer fills the role of general partner and outside investors act as limited partners, providing much of the initial equity financing. It is common for the developer share of the residual profit to be classified as “carried interest.”

Current law allows for carried interest to be paid at capital gain tax rates. Per the International Council of Shopping Centers,

“[H.R. 4213] will tax the “carried interest” proceeds of real estate partnerships and LLCs at 50% ordinary income and 50% long-term capital gains for two years, then move to a 75/25 split (75% ordinary)."

ICSC projects that with the passage of this bill, the tax on carried interest would increase by 108% over the first two years and then shift to a 156% tax increase once the 75/25 split is in place.

Although some observers believe this is a more equitable method of taxation, many commentators fear that this increased tax will lessen the incentives for entrepreneurs to develop new projects and reduce the flow of capital into real estate investments. For further discussion on this subject, please visit the following links:

http://www.taxpolicycenter.org/briefing-book/key-elements/business/carried-interest.cfm

http://www.cbpp.org/cms/?fa=view&id=562

http://www.naiop.org/governmentaffairs/issues/carriedinterest.cfm

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