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Resi Wrap - Death and Taxes
May 2021

Friends of ResiShares -

Taxes are in the news. Apparently President Biden was serious when he released a tax plan with significant changes to 1031 exchanges, basis step-ups, and capital gains.

Keynes once said that “the avoidance of taxes is the only intellectual pursuit that carries any reward.” He may well have meant this ironically, given that he is most commonly associated with a set of economic theories favoring a vigorous government intervention in the economy, but given how much real estate investment is favored for the tax benefits it confers, the subject is highly relevant to us.

To quickly summarize the gist of both articles’ real estate related points, the current proposal considers the following changes (disclaimer - no one at ResiShares knows anything about taxes, beyond the fact that we have to pay what our accountant tells us every year. Nothing in Resi Wrap should ever be construed as tax advice):

  • Imposing capital gains tax on asset transfer at death as if sold, with a $1 MM exemption per person.

    • This effectively removes the step-up in tax basis on transfer at death, because the heir pays for the step up when they inherit the asset.

  • Raising the capital gains tax to match the top income tax for high earners

    • This effectively closes the carried interest loophole for fund managers.

  • Eliminating the 1031 exchange on real estate profits over $500,000.

Given the game of whack-a-mole that is tax policy, we’re interested to see what new leaks spring from the system when these new holes are plugged. The Keyneses of the world certainly will not be sitting still while watching their effective tax rates go from 20% to 40%, and their inheritance taxes go from 0% - 40%, after all. Here are some thoughts that immediately come to mind:

1) Innovation in home equity access will accelerate - From reverse mortgages to HELOCs to the newer equity-sharing platforms, there are a variety of ways to tap home equity without triggering a taxable transaction. I can think of several ways that even today’s menu of options might facilitate avoidance of the above inheritance tax, and suspect that if it’s passed, more creative financial products will form that do so even more directly.

2) Not that we needed any more gasoline thrown on this fire, but as I read these proposals, it strikes me that single family rental (SFR) is heavily advantaged relative to larger format buildings. Why? An institutional or ultra-wealthy investor can subdivide their SFR portfolio into smaller assets, each of which can easily fit under the $500k exemption for 1031 exchanges.

3) If the above reading is correct, would it not similarly make sense that we see a great deal of apartment-condo conversions for the same reason?

Of course, to quote Louis XIV’s Minister of Finance Jean-Baptiste Colbert (perhaps the world’s most famous CFO until Andy Fastow), “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing.” It remains to be seen if this tax proposal achieves that objective without significant change, and we would do well to remember how different the 2017 tax bill ultimately was from its initial conception.

Rest of Resi

Have a great weekend,

Michael Greene

Co-Founder and CEO

ResiShares |