Last week you might have seen a lot of headlines about President Biden’s tax plan, with the overall theme that taxes will be increased for the wealthy. While that’s not an inaccurate takeaway, it’s also pretty simplistic: the proposal has a lot of moving parts, three of which I think are worth highlighting here.
Whether you agree with these measures from a political perspective is one thing, of course. But as far as I’m concerned, any changes in tax law may have an impact on your money regardless of which party implements them, and it is my job to tell you how.
1. Increased capital gains tax for those with AGI over $1M
First, the aforementioned capital gains tax is of course a biggie. Capital gains, or income from the sale of major assets such as stocks or real estate, will have a 39.6% tax applied for individuals earning $1 million or more under the proposal. When combined with a preexisting investment tax established by the Obama administration, the total tax would be as high as 43.4% for some.
This could make for some choppy waters: if investing becomes more expensive because it is more heavily taxed, fewer people will do it or will at least require a higher rate of after-tax return to make it worth their while. This could, in theory, decrease demand and drive down prices across the board. At least in the short run. You can even see the kneejerk reaction in real time, in fact, right after Bloomberg’s report on the tax hike was released.
2. No more stepped-up basis for appreciated assets
Not nearly as publicized was the proposal to eliminate the “step-up in basis” for appreciated assets. Currently, if you die and pass on assets with a gain like stocks or your house, then the “basis” of those assets’ value bumps up, from what it was when you purchased them to the current price when they are inherited.
This reduces the capital gains tax that your heirs would owe when they sell those assets. Under the new tax plan, however, that would no longer be the case – a major potential change to consider if you’re currently holding onto real estate (especially in a hot market like Seattle) with an eye to passing it down to kids or grandkids.
3. Possible elimination of the 1031 real estate provision
Finally, there’s rumor that future tax reform under Biden may also target 1031 exchanges. Named for the Internal Revenue Code section that provides for them, 1031 exchanges effectively allow landowners to “swap” properties, selling one and then buying another without having to pay capital gains taxes on the sale of the original property until eventually selling the second, swapped property.
So in a sense, 1031’s serve as a capital gains tax break, especially when paired with the stepped-up basis provision. Although they aren’t mentioned in the current tax plan, their close relation to other capital gains benefits still makes it seem their days are numbered.
Of course, even the measures that are clearly stated in Biden’s proposal are still hypothetical. But if nothing else, use this as a springboard to reflect on how concrete tax changes could affect your personal financial situation down the line. And if you want to find out more, here’s a pretty detailed breakdown of the whole proposal.