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Changes in real estate tax law for 2021 (Everything you need to know)

  • President Joe Biden will propose a capital gains tax increase for households making more than $1 million per year. The top rate would jump to 39.6% from 20%.
  • These changes may hit homeowners looking to sell in hot markets.
  • Those affected can reduce their tax bill with advanced planning, financial experts say.
Boston real estate taxes

Boston real estate taxes

As home prices soar, some sellers in red-hot markets may face a costly surprise come tax time.

President Joe Biden will propose in a nationwide address Wednesday a capital gains tax increase for the top 0.3% of households — those making more than $1 million per year.   

But the proposal may also deliver a tax bill to those selling a home with significant gains.

Wealthy Americans now paying the top capital gains rate could see a hike to 43.4%, from 23.8%. Both rates include a 3.8% levy on net investment income, created by the Affordable Care Act.  

The tax increases may impact more than stocks, bonds and cryptocurrency, however. Homeowners looking to cash in on sizzling home prices could also receive a bill.

“The proposed increase in federal as well as state capital gains tax rates could sting [home sellers] on the margins,” said Sharif Muhammad, founder and CEO of Unlimited Financial Services in Somerset, New Jersey.

Real estate tax exclusion

Even with median home prices reaching all-time highs, Muhammad said, many sellers avoid paying capital gains on home profits because of a special tax break.

Single taxpayers can subtract up to $250,000 from their profits, and married filers may qualify to exclude up to $500,000. Anything more is subject to capital gains taxes. 

There’s a strict IRS rule, though: It must be the seller’s primary home for two out of five years before closing on the sale, with a few exceptions, like a job- or health-related move

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Summary: In this Boston real estate blog post, find out what potential real estate tax changes to expect in 2021. The advice is from an experienced tax lawyer, including ways to minimize the downside of tax changes and maximize benefits.

Please note, do not take this information on face value, please consult with your tax lawyer/accountant. This is a guide, thus, use this information as questions you can ask your tax advisors

Proposed Tax Changes Across the Board in 2021

There are a number of tax changes the Biden administration has proposed, not just impacting real estate. These changes would potentially increase overall taxes for the wealthiest (top 1% or 2%) and reduce the tax burden for middle and lower classes. 

The laws that are in play range from income and estate taxes to long-term capital gains tax. Whether you own real estate or not, if one or many of these proposed tax changes get passed in Congress, every taxpayer will be impacted. The severity of the impact for high income earners may be significant, but as the saying goes, “Don’t count your chickens before they hatch”. 

Seasoned tax lawyer, Toby Mathis shared some great advice regarding potential tax changes in 2021.   “React rather than anticipate tax law changes.” Mathis says, “There are always last second changes to these laws. You never know what will be in the new laws until they’re passed.” 

Next we will introduce what exactly what laws are in play, why real estate investors need to pay attention, and how to minimize the downside of any proposed changes and maximize benefits. Stop the anxiety of Biden’s potential tax increases and prepare yourself for what may lie ahead.

What New Tax Laws Are in Play in 2021?

  • Transfer Taxes
  • Income Taxes
    • Individuals
    • Corporations
    • Trusts
  • 1031 Exchange/Step-Up Basis
  • Employment Taxes
  • Long-Term Capital Gains/Dividends

Proposed Transfer Tax Changes in 2021

There are a number of transfer tax changes that could happen this year. Below are some of the proposed changes.

Increase in Estate & Gift Taxes

Under current laws, there’s a 40% transfer tax on estates worth more than $11.58 million. This means that someone could leave an inheritance of $11.7 million and not be subject to federal estate or gift tax. 

Biden’s proposal is to increase estate taxes to a top rate of 45%. The plan would also decrease estate tax exemptions from $11.58 million to $3.5 million per person and $1 million for gift tax. 

Will this pass? Many experts say it’s unlikely.  However, if you have a lot of money and are afraid about getting hit hard by changes to estate and gift tax exemptions, now would be the time to begin a “gifting plan”. 

The annual gift exemption limit of $15,000 will remain unchanged in 2021. Meaning, individuals may give up to $15,000 to multiple heirs and pay no federal gift taxes. A married couple can each give away $15,000, which would allow for twice the gift amount with zero federal tax burden.

Possible Elimination of Step-Up in Basis

There have been talks of a possible loss of the step-up in basis. A step-up in basis works like this: Let’s say I bought a stock for $10 and it appreciated to $100. If I sold the stock before I died, I would get taxed on the $90 growth. If I hang onto it until after I die, my heirs would inherit the money tax-free. 

Right now, the step-up in basis states that upon death, capital gains taxes will be based on the value of the asset at the time of death or six months later, regardless of when it’s distributed to the heirs. 

While Biden’s plan regarding the step-up in basis is somewhat unclear, it’s likely one of two proposals will happen. First, taxing the gains that have not been realized by the decedent. This would mean the estate of the person who has passed would be required to pay the tax at death based on the estate or assets fair market value. The second option would be a scenario where the heirs would get a carryover basis at the time of death, and pay capital gains tax when the asset is sold–based on that basis. If either of these scenarios became law, appreciated assets would see tax increases.

Decrease in Exemptions on State Death Taxes

As of January 1, 2021, the death tax exemption in Washington D.C. decreased from $5.67 million to $4 million. So if a resident of D.C. with a taxable estate worth $10 million dies in 2021, the heirs would have to pay almost $1 million in estate taxes. The District of Columbia and 17 other U.S. states issue an additional tax on estates or inheritances.

Adjustments to Trust Taxes

Changes to how trusts are taxed could be coming in 2021. The Grantor Retained Annuity Trusts (GRATs), Spousal Lifetime Access Trusts (SLATs) and/or Dynasty trusts may be adjusted or done away with altogether. While these changes haven’t occurred yet, those that hold their estates in a trust should be aware of these changes potentially coming.