Inflation and Proposed Tax Changes

Commentary from a Broker, Owner and Manager Perspective

By CRaig KiRKPatRiCK, ViCe PResident, moRgan sKendeRian inVestment Real estate gRouP

Inflation and Proposed Tax Changes

Rising inflation and tax changes are two developments that have recently surfaced, so let’s take a look at them.

INFLATION —

As of the writing of this article, inflation has spiked. Depending on who you listen to, you either think the “sky is falling” or there’s nothing to worry about and this inflation spike is transitory. In April, the inflation rate of 4.2% topped mortgage rates of 3.1% for the first time since 1980.

The Fed, however, believes this is transitory. The Fed has a tough juggling act to keep inflation mild and employment high, and has done this largely by keeping interest rates historically low. Now, the Fed is ignoring new inflationary hints like soaring prices in commodities (gas prices), durable goods (used autos) and homes (record values) that this low interest-rate policy helped create.

However, the Fed says an increase shouldn’t be a surprise, especially in light of the economy evolving out of the COVID pandemic at unprecedented rates and in untypical ways. For example, three sectors — used autos, public transportation and lodging away from home, though making up only 6.5% of core CPI, imposed a major impact on the inflation trend. For instance, used autos, largely due to semiconductor shortages stunting new car production and sales, made up nearly one-third of the 3-point rise in Core CPI. Of course, we know that recent price increases in airline fares and hotels and motels reflect the easing of COVID- related restrictions.

The Fed believes these one-time increases of prices are likely to have only transitory effects on inflation and expects inflation to return to — or slightly above — their 2% long-term goal in 2022 or 2023. This is open for much debate, and opinions seem to swing as new data points are released.

TAXES —

President Biden recently proposed tax code changes that, if passed, would dramatically change our tax and estate planning. Though this is a proposal only, the president whose party controls Congress is proposing it. President Biden says this proposed change to the tax code would fund his multi-trillion “American Families Plan.”

Here are some of the highlights or lowlights:

Basically, the three aspects of our business that are threatened are:

1. 1031 Tax-Deferred Exchanges 2. Capital Gains Tax 3. Step-up in basis

Limitation on 1031 Tax-Deferred Exchanges:

The proposed change to IRS Section 1031 would affect real estate investments where the profits exceed $500,000. Nationwide, approximately 70% of deals included a 1031 exchange with 80% of these transactions exceeding $500,000 in deferred gain. This would affect most all of us!

Increase in Capital Gains Tax:

Today the Federal Capital Gains Rate is 23.8% (includes Capital Gains Tax + Medicare Surcharge on Net Investment Income). Biden’s proposal would increase this Capital Gains Tax rate from 23.8% to 43.4%. Adding in California’s rate of 13.3% would push the total to 56.7%.

Elimination of Step-up Basis:

The bill includes an exemption of $1 million for individuals and $2 million for married couples, but eliminates step-up above these levels. The increase in capital gains tax and elimination of the step-up in basis go hand in hand in efforts to increase tax revenue from real estate owners. This would affect our heirs.

If passed, there are three options on the table as to when these tax changes might be implemented: 1. Retroactive to January 1, 2021 (unlikely) 2. Date bill is passed; and 3. January 1, 2022.

To summarize:

• We know the capital gains tax is as low as it will be, but we won’t know the increase until the bill works its way through Congress.

• Every owner has di erent wants and needs • Monthly cash ow statements • Rent rolls & check registers • Bi-lingual sta • Fee management service • Temporary vacation management service • Rent up management service • Award winning seasoned professional team • Immediate availability for owners and tenant needs • Rapid response & 24 hour emergency availability • Expert monitoring of local rental trends and legal developments • Routine maintenance, exterior/interior inspections

We take care of your business, your residents & your peace of mind!

DRE01460075

For Information: 714.778.0480 Contact: Denise Arredondo

Email: denise@contactjle.com • www.ContactJLE.com • 202 E. Broadway, Anaheim, CA 92805