Proposed Changes to U.S Tax Policy
By Michael Repka, Esq. LL.M. (Taxation) NYU School of Law
THAT COULD IMPACT SILICON VALLEY REAL ESTATE
Whenever there is a change in administration, there is an inherent uncertainty related to tax policy. Fortunately, during the presidential campaign, now-President Joe Biden laid out a pretty clear blueprint for his tax proposals. Although it is inevitable that there will be negotiation, compromise, and changes that alter the legislation ultimately enacted, this article will delve into some of the proposed changes that could impact Silicon Valley real estate.
Increase to Capital Gains Tax Rates
Without question, the biggest proposed tax change that could impact Silicon Valley real estate is the proposal to increase the federal capital gains tax rate from 20% to 39.6%.
As proposed, this change would only impact taxpayers with adjusted gross income (“AGI”) in excess of $1 million. However, one should note that the gain on the property being sold will likely be included when applying this $1 million limit. As such, a couple who is making $800,000 a year in combined income from their jobs and other investments may be lulled into a false sense of comfort because their income is less than $1 million. However, if they have a hypothetical taxable gain of $900,000 on the sale of their home, that $900,000 would have to be added to their $800,000 in other income, thus pushing them well beyond the million dollar threshold.
Likely Impact on Silicon Valley
If this tax change is enacted, it is likely that some homeowners will rush to sell before the effective date. Although it is impossible to know when this change will become effective, it is unlikely that it will be retroactive to the beginning of 2021 despite the fact that the prohibition against ex-post facto laws has been determined not to apply to tax changes. It is my prediction that the harshness of enacting a law retroactive to sales that were consummated prior to the date the legislation was passed will be enough to make it untenable to legislators.
However, it is also unlikely that the tax changes will take effect at some date in the future because that type of structure would result in a mass dumping of assets onto the market, thus creating dire economic consequences.
Consequently, it is likely that legislation will be enacted with an effective date contemporaneous with the bill’s passage out of the House Ways and Means Committee. Taxpayers may then have some advance notice before the pivotal date, but not much.
The Elimination of Step-Up in Basis
Although far less fleshed-out than the proposed increase to capital gains taxes, in passing then-candidate Biden mentioned closing tax loopholes such as the step-up in basis rule.
Under current law, when someone inherits property, they take the property with a basis equal to the fair market value on the date of death of the decedent. In other words, all of the capital gains that the decedent would have paid if they had sold the property is permanently forgiven. This is what is known as a “step-up in basis.”
Because California is a community property state, the death of one spouse results in a full step-up in basis of assets held as community property with rights of survivorship. This is a tremendous tax advantage.
If this taxpayer-favorable provision is eliminated, there will be even more of an increase in the supply of homes on the market. Currently, many Silicon Valley homeowners are refraining from selling their property because they know that their heirs will take a stepped-up basis. If that benefit is eliminated, many homeowners with substantial appreciation will refrain from waiting and elect to sell their properties and move out of the area.
Proposed State Tax Changes
Although the California legislature introduced legislation to increase state tax rates from an already high 13.3% to as much as 16.8%, this legislation was defeated. Nevertheless, there have already been calls for re-introduction of similar legislation.
Similarly, there have been proposals to increase the California corporate income tax rate from 8.84% to 9.6% (Assembly Bill 71)1 .
If California continues to increase state tax rates, it is inevitable that companies and individuals will continue to consider moving to lower tax states. The favorable attributes of California are undeniable and compelling, but only time will tell how much people and businesses will continue to pay to remain here.
