The Silver Lining Behind Tax Increases

Increased Taxes

There has been a lot of bad news the last couple of years and the latest round of bad news warns of higher taxes on the horizon. For example, the law that lowered the capital gains tax rate to 15% has a sunset date and is scheduled to expire this year, which will result in a maximum capital gains tax rate of 20% in 2011. This will happen automatically without any action on the part of Congress. Starting in 2013, there will be a new tax of 3.8% on unearned income, which includes income from the sale of real estate, imposed on taxpayers who earn more than $200,000 ($250,000 for married couples filing jointly). This tax was part of the health care bill and essentially raises the federal capital gains rate for high income earners to a maximum rate of 23.8%. On the partnership front, there has been a proposal to tax carried interest at ordinary income tax rates rather than capital gain tax rates, and although this proposal has been temporarily shelved, many people believe that the idea is not dead and may come back later this year or next year. In addition to all of these federal tax changes and proposals, many states are looking for cash and proposing to increase income and property tax rates.

Increased Activity

For some real estate investors, agents and brokers, there is a silver lining to this cloud, as the anticipated increase in taxes should result in an immediate increase in activity in the marketplace. The possibility of tax increases starting in 2011 may encourage investors to sell their properties and cash out in 2010 because, as taxes increase, investors know that they have to sell their properties for a higher sale price in order to have the same level of profits. If property values don’t rise at the same rate as taxes, these profits are better taken now than several years from now. Although this activity may not increase the number of 1031 exchanges this year, it should increase the number of transactions between now and the end of the year.

The increase in activity that is spurred on by increased taxes should continue in 2011 because the consensus is that taxes will go up even further as Congress begins to feel that the economy is improving. Particularly in 2011, these factors should also encourage more investors to do 1031 exchanges. If structured properly, in most cases a 1031 exchange will allow an investor to defer all federal capital gains and state capital gains taxes indefinitely while using the savings to acquire more property.

As baby boomers are approaching retirement age and considering cashing out, 2010 is an opportune time. Other investors who are ready to trade up or diversify and have adequate cash for a substantial down payment may want to take advantage of low interest rates and exchange into a new property. In an era of bad news, there are opportunities for those who know where to look for them.