Impact of Biden tax plan on STR investing?

Question

With a Biden Presidency, taxes on on everyone making $400K a year are going up.  There is speculation that the "only" 20 percent capital gains tax will go up, and in fact, for folks making $400K a year, capital gains tax will revert to ordinary income tax which could be as high as 40 percent.

"But I don't make $400K a year".  Well, if you sell a STR for $400K and your basis is $200K, you are likely now in the top bracket for that year, when you combine that gain with your personal income.

Number one, what does everyone think the practical effect on STR investing will be, if any?  More demand?  Less?  Higher prices?  Lower?

As I navigate this for myself, my strategy is simply "don't sell, but refinance".    In other words, in the low interest rate environment, rather than selling a unit for big gains, I'll just do a 75% cash-out refinance and service a 3% loan.  The loan obviously isn't capital gains or income.

Example:  I have a property that is likely worth $550K FMV today that produces about $60K a year in top line rents.  My basis is around $280K.   If I sold it, I would have a capital gain of $270K.  Under the Biden plan, my taxes on that would likely be in the $100K range.

Instead of selling, I would do a cash-out refi:  A new loan of around $450K @ 3.25% APR.  So I get $450K out of the property through a "loan", thereby avoiding capital gains tax, and the rental income now services the debt (plus quite a bit more actually).

But my overriding question is, "What effect on STR investing will the Biden taxes have?"

Julie McCoy · Answer

@Collin H. The most straightforward way to avoid a tax hit on a property sale is to either do a 1031 exchange or invest the gains in an opportunity zone or other tax-deferred investment.  I know Biden has floated the idea of eliminating the 1031 exchange, but until that actually happens (I think there would be VERY strong headwinds against this) I am going to continue utilizing it.

If you're fine with holding the property, yeah, cash-out refi or a line of credit is the way to go, but that doesn't address the question of gains when the property sells.  I believe there are certain limitations on this, so check with your tax professional, but if you were to do a cash-out refi for the maximum available amount (let's say 75% LTV) and then turn around and sell the property, your gain would be approximately 25% - which would be a better tax outcome than if you had a gain of 50%.  However, I believe the IRS frowns on cash-out refis and then selling a property quickly thereafter, so definitely something you want to do with professional advice.

Outcome for the STR market?  Savvy real estate investors have a plethora of tax benefits they can take advantage of, and while any new tax regulations will prompt adjustments to strategies, I have every confidence that this will continue to be one of the most tax-advantaged means to generate income.  Real estate investors will continue to utilize the 1031 exchange and that will eliminate most concerns about taxes on income.

Until there's a more concrete idea of what any new tax law will actually look like, I don't anticipate any changes to the market, and once we have that there will be new strategies born.

Luke Carl · Answer

@Collin H. there are so many benefits to real estate I’m not concerned. I don’t live my life on What Ifs but IF my taxes go up I’ll just need to buy more property to have more deductions. Poor me!

Basit Siddiqi · Answer

Most LLC's are "pass-through" entities so they get reported directly onto your tax return.

Michael Baum · Answer

I don't disagree with your assessment. Rarely does the government make decisions that are rational. Especially now. Hopefully you are right.

Michael Baum · Answer

I agree with @Julie McCoy. But I do see the 1031 exchange going away. Most non-real estate investors think that the rest of us are fat cats with tons of dough and that we deserve to get taken down a peg. Seeing as the 1031 only benefits investors, it might be considered low hanging fruit.

It's funny, when we bought our vacation home, some people thought we were flaunting all this money we didn't really have. Being disabled in my prime cost us a huge amount of future earnings. Doing a STR has allowed us to do better. To plan for the future, how ever long that is.

Ryan Moyer · Answer

I'm not going to stress about it until we actually see what it is.  For instance I'm not sure where the notion that capital gains over $400k would be taxed at the ordinary rate is coming from as everything I've read said this would only affect earnings over $1 million, not $400k.  In that case I can only hope I get to the point where I have to worry about that.

37% to 39.6% increase in just the income that falls into the highest bracket isn't something I would probably bother changing my overall strategy for unless I was making some insane amount of money well over $400k/year.  Even if you make $500k one year that's only a $2600 difference in taxes for the year compared to current rates.

Tax rates have been much higher than 39.6% before and real estate investors still seemed to do fine, alongside much higher interest rates to boot.

Nancy Bachety · Answer

@Michael Baum Fully taking away the 1031 would hurt financial institutions and residual real estate companies. They would write fewer new, bigger loans if owners are de-centivised to sell, making less money, making less donations, and having huge impacts on the economic system. Recall they were bailed out when profits tanked. The deficit has the capacity to go to infinity, it’ll never be balanced. But, we’ll wait and see what happens, and respond/adapt accordingly.

Nancy Bachety · Answer

1031 exchanges becoming more popular than they are now is a possibility. It could be an exit plan in your example. I’m doing one shortly with a LTR into a STR. Depreciation is going to only take you so far when you’ll want to move on, whether you cash out refi or not.

Joshua Strickland · Answer

I wonder if splitting properties into multiple LLCs would solve this? Possibly do a quitclaim deed to transfer properties into individual LLCs that way even if you sold and made a cool $250k, etc. it would be under the $400k max and keep the long term capital gains tax rate. (I’m not a tax pro though, so maybe that doesn’t make sense.)

Impact of Biden tax plan on STR investing?

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