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The House Ways and Means Committee has released new tax proposals, many of which increase taxes for those making more than $400,000. The proposals include a variety of provisions that impact estate planning, real estate investing and small businesses. While there are increases, it’s not all bad news. There are a variety of previous provisions that have been left out that could have had a major impact on your tax bill. Let’s break down the good and bad news surrounding these proposals as it pertains to each category.
The first piece of good news is that there’s no mention of eliminating the 1031 exchange, a tool used by many real estate investors. Also left out is the elimination of bonus depreciation. Under current law, owners of qualified properties are eligible for 100% bonus depreciation in the first year, so as it stands, this will remain untouched. The bad news is that real estate carried interests would only be allowed long-term capital gain treatment if the project is held for more than three years. This means that instead of a 20% rate, real estate carried interests could be taxed at a 39.6% rate like ordinary income. Additionally, it’s proposed that IRAs will not be allowed to invest in syndicated investments such as multi-family projects.
The good news regarding estate planning is huge. While there had been a lot of discussion surrounding a potential capital gains tax at death, it was left out of the current proposals, maintaining the current step-up in basis. Additionally, there are no plans to tax lifetime transfers. Now for the not quite bad, but not great news. Up until now, with a defective trust, you’ve been able to transfer an asset, like ownership in your business, real estate or even stocks, out of your estate and still pay income tax on the asset. Under this proposal, this would be eliminated, and it would be out of your estate for income tax purposes. There’s also a proposal to change valuations when it comes to marketable securities. If passed, you will not get a discount when you transfer them. The final change is a 50% reduction of the estate and gift tax exemption from $11.7 million to $6 million.
Small family-owned businesses
Unfortunately, there is no good news for families that own a small business. In the new proposal, investment in a partnership that goes bad, which under current law would be an ordinary loss, will now be a capital loss. This change would be impactful as capital losses can only offset capital gains while an ordinary loss can offset any type of income. The proposal also reduces the Section 1202 gain exclusion from 100% to 50% if your income is more than $400,000. The Qualified Business Income Deduction, which is normally thought of as the 20% deduction for pass-through entities, would have a $500,000 limit or may even possibly phase out completely after $500,000 while it currently has no limits aside from the industries that qualify. Finally, the net investment income tax would apply to passthrough business income over $500,000.
While we now have a better look at what may be the future of tax legislation, it’s important to know that this is ever-changing. It’s important that you begin your tax planning now while working closely with your tax advisor to monitor any additional changes that could greatly impact your taxes and your wealth.