"Earth to Earth": Actual Property, Dying and Biden's Tax Proposals

Looking for real estate?

During the 2020 presidential campaign there was a segment of the "rich" for which then-candidate Biden apparently reserved some of his harshest criticisms – wealthy real estate investors. In addition, the Democratic Party platform contained several proposed amendments to the Code (i), the effects of which these investors would likely feel most strongly. (Ii)

Inquire about the origin of this attitude. Was it – pun intended – in the party's association with the Trump industry, rightly or wrongly with Mr Trump? (Iii) But how can this be reconciled with the significant contributions from industry leaders to the Mr Biden and Mr Biden campaign? political action committees that supported him? (iv)

Regardless of why Candidate Biden cited federal real estate taxation as an example of what he termed (v) President Biden as special treatment for the rich by the Code, he recently proposed that the Code be amended to limit many of the favorable provisions Real Estate Is Based On Real estate investors have long relied on valuing the purchase, operation, and sale of investment property.

Biden's suggestions and some observations

You may recall that late last month the White House published a summary (vi) of the President's proposed changes to the Code as part of his American family plan. (Vii)

The following describes four of the proposed changes that may be of particular interest to people who invest in real estate or who have interests in related companies that hold real estate investments. in particular, the increased tax rate on capital gains, the elimination of the increase in the base of a taxpayer's assets upon death of the taxpayer, the presumed sale of a taxpayer's assets at the time of his death and the limitation on the use of similar exchanges.

These descriptions are accompanied by observations that can be helpful in considering the impact of the proposed changes on a taxpayer and their tax planning.

Increased rate for capital gains

An increase in the top tax rate on long-term capital gains from 20 percent to 39.6 percent for those earning more than $ 1 million. (Viii)
- The tax on the gain on the sale or exchange of real estate that the taxpayer has held for investment or use in a trade or business (ix) for more than a year will almost double. (X)
- The same rate hike applies to long-term capital gains from the sale or full liquidation / redemption (xi) of a company stake or shares in a company in which the business unit owns real estate.
- The higher rate also applies to dividend distributions by a company.
Inquire if taxpayers will try to stay below the $ 1 million threshold that will trigger the higher tax rate.
- Installment sales may be an option provided the credit risk of the deferred payments is acceptable.
  - Consider an installment obligation guarantee (xii) by a party connected to the buyer, or possibly a standby letter of credit.
- A taxpayer must be aware of the special interest charge that applies to installment obligations in excess of $ 5 million. (Xiii)
- The taxpayer must also understand that the gain on certain assets does not qualify for rate reporting. For example, re-recording depreciation for those taxpayers who may have used a cost segregation study to expedite the depreciation of certain components of a property.
Other taxpayers may choose to close a transaction before the end of 2021 (assuming an effective January 1, 2022 – stay tuned) to secure the lower tax rate.
- To ensure the greatest possible flexibility, a taxpayer can consider receiving part of the purchase price for a property for sale before the end of the year together with an installment slip. Depending on the amount of the rate hike or the timing of the rate hike, the taxpayer may decide to opt out of rate reporting and report the entire profit represented by the note in 2021. (xiv)

Limit the basic step-up at death

With the adopted sales rule. Eliminate the base increase (xv) for property acquired or given (xvi) from a deceased if the inherent gain on property at the time of death (xvii) exceeds $ 1 million ($ 2.0 million per couple (xviii)) .
- Inquire about the implications of this change if the previously “sold” valued asset to a grantor trust whose deceased is treated as owner for income tax purposes (xix) in exchange for a promissory note (xx) is the “sale” at the time of Death of the grantor completed when the trust is no longer disregarded for income tax purposes? (Xxi) If so, subsequent lump-sum payments become taxable according to the installment sale rules. (Xxii)
- The death of a partner has long been considered an appropriate time to adjust the portion of the estate to the adjusted basis of the partnership for his wealth (the "inner base"). (Xxiii)
  - The amount of this adjustment is determined by comparing the adjusted base of the estate for its partnership shares (the “external base”) with its share of the internal base. A positive base adjustment is treated as a new asset that can be written off from the estate (assuming that the adjustment in its portion of the inner base is mapped to a depreciable asset).
  - The adjustment can also be used to reduce the partnership's share of the profit of the estate on the sale of the property to which the adjustment is attributable.
  - Eliminating the elevation of the base at death seems to deprive the estate of the ability to adjust its portion of the inner base with reference to its reinforced outer base. (But see below.)
- Without the rule that applies to sales. If the adopted sales rule (below) doesn't go into effect – and I think it will be difficult for Congress to accept such a significant change – the loss of the base increase has a better chance of going into effect, subject of a palatable amount of exemption – as noted above, $ 1 million has been suggested. (xxiv)
  - The repeal of the basic step-up rule affects everyone who receives property from a deceased, be it due to the will of the deceased, revocable trust or due to legal provisions (for example someone who jointly owns real estate with the deceased , with the right to survive, so that the interest of the deceased passes to them after the death of the deceased).
    - By denying these individuals an increase in the base of the property they receive after the death of the deceased, these individuals will make a greater profit from the subsequent sale of the property.
      - This will become more important for real estate if Congress also follows Mr Biden's proposal (see below) to restrict a taxpayer's ability to use a similar exchange to defer the recognition of gains on real estate sales.
    - In the case of depreciable property (e.g. a building), the individual beneficiary loses the ability to write off the additional basis that would have been provided by the addition, effectively making ownership of the property more expensive.
    - This also has an impact on beneficiaries who preserve partnership interests, especially when the partnership is used extensively. The transfer of such interest after death will be treated as a chargeable event even if the transferee does not receive cash – the amount of company debt that has been allocated to the deceased's interest for tax purposes (as indicated in the Sch. K -1) treated as a cash payment to the transfer recipient; basically phantom income. (xxv)

Considered a sale on death

Tax the gain inherent in a deceased's property (minus a $ 1 million gain – consider it an exemption) as if the property had been sold to a hypothetical unrelated buyer (xxvi) for an amount which corresponds to its market value at the time of death.
- The elimination of the base increase in the event of death (see above) means that this sale, which is considered a sale, is taxable.
- Assets considered sold include the deceased's direct and indirect shares in real estate.
  - Indirect shares include shares in a company or shares in a partnership that owns real estate.
- The profit from this is determined by reference to the adjusted basis of the deceased in the property "sold" immediately before their death. (Xxvii)
- The deceased's estate pays income tax on the presumed sale. Presumably, the estate is entitled to a deduction of the tax paid to determine its estate tax liability.
- Assuming Congress increases the capital gain rate (xxviii), which seems likely, the amount of tax owed on the presumed sale could be substantial, especially for highly valued assets.
  - How does the estate finance federal income tax payment? If states comply with the proposed federal change, state and local income taxes must also be considered.
  - Will the deceased's estate also be subject to federal estate tax? The President's proposal does not mention inheritance tax.
    - In the absence of other guidelines, both taxes can apply to the same estate.
    - Income tax may apply to an estate that is not currently subject to estate tax. (Xxix)
  - Insurance over the life of the deceased taxpayer can play an even bigger role in providing the liquidity the estate needs to cover both income tax and estate tax.
- However, after such a presumed sale, a beneficiary of the deceased's estate will take the deceased's property on a basis equal to the fair value of the property – an increased basis – since the profit has already been taxed once (on which it is considered a sale).
  - The subsequent actual sale by the estate or the beneficiary does not result in the profit built in before death being taxed again.
  - The increased base gives the beneficiary an asset that can be depreciated in the future, at least if the deceased owned a direct interest in real estate
  - This should result in the fact that in the case of a deceased who had a share in a partnership for which an election was carried out according to § 754, the portion of the estate can be adjusted in the inner base.
  - The S-Corporation Rules do not provide for a similar internal base adjustment with respect to the corporation's assets.
- According to the rule of the assumed sale, a profit would also be realized and taxed if the value of the property was not revalued, but the basis for the property adjusted by the taxpayer – or for their indirect interest in the property (for example the basis for) theirs Partnership shares) – were reduced due to depreciation and other deductions asserted in relation to the property.
- Is it strange that a smaller estate that is not subject to federal estate tax (because the taxable estate is less than the amount of federal estate tax exemption) should get a base increase on its estimated wealth (and generate no income)? Tax), while a larger estate that is subject to estate tax can be refused the base adjustment and is therefore taxed twice on the same property (xxx) – once for income tax purposes and once for estate tax purposes.

Limit the Like Kind Exchange

Eliminate the similar exchange (xxxi) for properties where realized profit exceeds $ 500,000.
- This seems to be a limit per investor. However, the President's proposal contains few details. (xxxii)
- It is also likely that this will be an annual limit; In other words, a single taxpayer cannot defer more than $ 500,000 in profit in a single tax year with similar exchanges, including exchanges from partnerships or S companies owned by the taxpayer (to the extent of the taxpayer's interest).
  - Inquire if the owner of a property that is being held for investment and making a significant profit should bring the property into a partnership with family members. If done well, before considering a disposition, the partnership should meet the qualified use or "held" requirement of the same type of exchange rules while enabling the family to avoid any potential limitation on deferred profit per taxpayer adopt to benefit. (xxxiii)
- A taxpayer planning to dispose of real estate (the property assigned) in a similar exchange should consider exempting the new regime this year (assuming it comes into effect January 1, 2022) (xxxiv).
- A New York resident who has been considering “removing” his or her New York property by selling that property and using a similar exchange to purchase replacement property in a more tax-friendly jurisdiction may want to implement that strategy sooner than later.
  - Such a transaction can be used as part of a New York Taxpayer (xxxv) estate reduction plan, to position the taxpayer for gifts that are not covered by the claw back rule, or to aid the taxpayer's claim of being resident in Leaving New York. xxxvi)
- Although the change would apply to direct swaps of property, delayed conversions, and reverse conversions, you should ask yourself if it also applies to the mixing bowl rule exception, which avoids recognition by a contributing partner when the partnership acquires the property brought in Distribute a non-partner – contributing partner and distribute equal ownership to the contributing partner. (xxxvii)

Farewell Thoughts

It is up to the individual real estate investor and his or her advisors to examine the above legislative proposals (and related observations) more closely and to envisage the possibility that one or more of these provisions will be enacted as proposed or more likely in a modified form. This process prepares the taxpayer to respond effectively and relatively quickly when needed.

Other points to consider include using life insurance held by an irrevocable life insurance fund to replace "lost economic benefits" that would otherwise have been realized by topping up the base. The beneficiary receives the income tax-free life insurance proceeds. The deceased can donate or borrow the amount of the award. (Xxxviii)

Life insurance companies can also be prudent in the event that the presumed sales rule is enacted, especially in the case of an estate that consists mainly of real estate shares and has little cash. (Xxxix)

Finally, stay up to date on what's happening in Washington, DC – and follow our posts.

A word about the title. The full sentence from the Anglican memorial service is "earth to earth, ashes to ashes, dust to dust".

(i) It shouldn't require clarification, but there is only one “code” for the benefit of new readers: the Internal Revenue Code. Distant competitors for the title include the Justinian Code (which provided the basis for legal regulations across Europe – but the West continues to ignore its debt to Byzantium) and the Hammurabi Code (known for its "If This, Then That" Format, not to mention) its very harsh penalties – the so-called "laws of retribution"). The bankruptcy code (lowercase "c")? Not as much.

(ii) For example, at some point the candidate requested the elimination of bonus depreciation for real estate. According to this rule, a taxpayer can immediately deduct the cost of property improvements (e.g. landscaping) with a useful life of up to 15 years.

During the primaries, other candidates questioned the need for real estate depreciation allowances, which tends to lead to appreciation.

(iii) A perverse application of the law of transitivity: Dems hate Trump; Trump likes real estate; Dems hate real estate? Perhaps it would be more accurate to characterize the position as derived from the concept of "guilt by association"?

(iv) https://therealdeal.com/2020/09/10/real-estate-donors-backing-biden-over-trump/.

(v) You can take advantage of these real estate investing offers: https://www.realtymogul.com/knowledge-center/article/20-famous-real-estate-investing-quotes.

(vi) https://www.rivkinradler.com/publications/tax-highlights-the-american-families-plan/.

(vii) https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/28/fact-sheet-the-american-families-plan/

(viii) Mr. Biden has proposed increasing the highest federal income tax rate for individuals from 37 percent to 39.6 percent. This increased rate applies to interest payments on loans made by a single taxpayer-lender to a business entity to assist it in acquiring or improving real estate. It also applies to the share of an individual in the normal business income of a partnership or an S-company from a real estate transaction, as well as to their share in the net rental real estate income. See lines 1 and 2 of Part III of Sch. K-1 to Form 1065 (partnership tax return) and to Form 1120-S (S corporation tax return).

And do not forget the 3.8% additional tax on the net investment result in accordance with IRC Sec. 1411 if the individual taxpayer is not a significant party to the business. See IRC Sec. 469 and Reg. Sec. 1.1411-5.

(ix) IRC Sec. 1223.

(x) IRC Sec. 1 (h), Sec. 1221 and Sec. 1231.

(xi) It never hurts to remind people that the profit a partner makes in liquidating their stake in a partnership is generally treated as profit from the sale or exchange of the company's stock, which in turn is treated in general is expressed as a profit from the sale or exchange of a capital asset. IRC Sec. 736 (b), Sec. 731 (a) and Sec. 741

As always, when dealing with a partnership, pay attention to “hot assets” according to IRC Sec. 751 and the assumed distribution of cash according to IRC Sec. 752

If the liquidation of a company share is brought about by a material distribution of property, check whether the "Mixing Bowl" rules of IRC Sec. 704 (c) (1) (B) or Sec. 737 apply.

(xii) IRC Sec. 453 (f) (3).

(xiii) IRC Sec. 453A.

(xiv) IRC Sec. 453 (d). The choice must be made on or before the due date (with extension) for the yield above which the sale is reported.

(xv) IRC Sec. 1014.

(xvi) Inquiry as to whether this includes property that the deceased gifted during his life but that is included in his gross estate for federal estate tax purposes; For example, because the donor continued to enjoy the economic benefits of gifted property. IRC Sec. 2036.

This property is currently subject to a basic adjustment in the event of the death of the deceased donor. IRC Sec. 1014. Indeed, there are times when the deceased's estate, otherwise subject to estate tax, tries to include the gifted wealth in the gross estate to ensure a top-up on the base.

(xvii) The excess of his fair value over the deceased's adjusted basis, both determined at the time of death.

(xviii) Does this mean some sort of portability rule, similar to the one that allows a surviving spouse to take advantage of a previous spouse's unused inheritance / gift tax exemption?

(xix) IRC Sec. 671 ff.

(xx) The involvement of Rev. Rul. 85-13 underlies such transactions.

(xxi) See my article on the Internet at https://www.taxlawforchb.com/2015/08/sale-to-idgts-the-death-of-the-grantor/.

(xxii) IRC Sec. 453

(xxiii) The partnership must choose to make this adjustment. it's not automatic. Once the election is made, it will apply to any subsequent transfers for which an internal base adjustment may be available. IRC Sec. 754 and Sec. 743

(xxiv) I can see this is $ 5M when adjusted for inflation to match the inheritance tax exemption (this was the basic exclusion amount prior to 2018 and will be reintroduced from 2026 if not earlier). In this way, an estate that is not subject to estate tax is also not subject to income tax. (I hope you read this in Washington.)

(xxv) IRC Sec. 752. I prefer to think of it as regaining tax benefits that stemmed from the debt.

Partners in burned-out tax homes relied heavily on the increase in the base upon partner death to avoid this phantom gain. See Reg. Sec. 1.742-1 (a), according to which the adjusted basis of partnership shares of a deceased is equal to the fair value of the interest plus the amount of the partnership debt, which corresponds to the interest according to IRC Sec. 752 and the provisions below it.

(xxvi) Finally, the fair value of a property is the price at which the property would change hands between a hypothetical willing buyer and a hypothetical willing seller without being forced to buy or sell and both of them have adequate knowledge of relevant facts.

You can find an overview of the income tax consequences of sales between related parties in my article on the Internet at https://www.taxlawforchb.com/2013/12/related-party-sales/.

(xxvii) The removal of the increase makes this sale taxable.

(xxviii) Whether 39.6%, as suggested, or a lower rate – I think 24.2%; Adding the 3.8% Obamacare tax (per IRC Sec. 1411) would increase the tax rate to 28%.

(xxix) The latter doesn't make sense. Income tax exemption (as proposed, $ 1 million profit per deceased) should be equivalent to inheritance tax exemption. If an estate is to be exempt from estate tax, it should also be exempt from income tax. This can become a negotiating point if the amount of inheritance tax exemption is included in the legislative dispute.

(xxx) Such an outcome provided the historical justification for increasing the base – to avoid having both inheritance tax and income tax levied on the same property.

(xxxi) IRC Sec. 1031 and the regulations proclaimed therein.

(xxxii) For example, is this an exchange rate limit or an annual limit?

(xxxiii) Questioned whether Congress can include attribution rules in legislation to thwart this strategy.

(xxxiv) Really grandfather. The replacement object can be purchased under applicable law.

(xxxv) NY Tax Law Sec. 954.

(xxxvi) New York has not yet passed a rule like California's that "tracks" the investment of the proceeds from the sale of a state property to a replacement outside of the state. If the replacement home is sold in a taxable transaction, the California deferred gain must be taxed.

(xxxvii) IRC Sec. 704 (c) (2). See my article on the internet at https://www.taxlawforchb.com/2017/03/effecting-exchanges-of-property-through-a-partnership/.

(xxxviii) Perhaps as a form of the private split dollar.

(xxxix) However, loans secured by the real estate may be possible; For example Graegin Loans. See my article on the internet at https://www.taxlawforchb.com/2017/05/paying-the-estate-tax/.