After a chaotic 23 hour struggle regarding the fiscal cliff, the drama in Washington came to a close late Tuesday, January 1, 2013 as the fiscal cliff deal passed the U.S. House of Representatives and Senate. The legislation, entitled The American Taxpayer Relief Act, was signed into law by President Obama the next day.
Though the deal averted an immediate budget crisis, it set the stage for months of renewed confrontations between Republicans and Democrats over the debt ceiling, entitlement reforms, spending cuts beyond a two-month delay of massive budget cuts, and a long-term plan for deficit reduction.
While the new law provides many benefits for the commercial real estate industry (listed below), abrupt and complicated changes to the capital gains and personal income tax rates could hamper the sector’s recent recovery. Specifically, the law raises the top capital gains and dividend rate to 20% for taxable income exceeding $450,000 for couples and $400,000 for individuals. However, the 15% rate is preserved for those with taxable incomes below the $450,000/$400,000 threshold. Additionally, the law permanently extends Bush-era personal income tax rates for taxable income up to $450,000 for couples and $400,000 for individuals. Taxpayers earning more than these thresholds will see their top marginal rate rise to 39.6%, up from 35%.
Furthermore, the law may create some confusion for taxpayers that have both ordinary income and capital gains income. For example, how would a married couple calculate their capital gains rate if they earned, say, $300,000 in ordinary income and $500,000 in capital gains?
In essence, the government will look to the amount of ordinary income first in determining whether capital gains are subject to a 15% or 20% rate. Assuming a married, joint filer return, their capital gains income would be stacked on top of ordinary income. If the total income crosses the $450,000 threshold, only the gains in excess of the $450,000 are taxed at 20% and the gains below the threshold remain at 15%. Using the example above, since the $300,000 of ordinary income is well below the $450,000 threshold, the first $150,000 of capital gains is taxed at 15% and the remaining $350,000 is taxed at 20%.
Because the deal simply moved the trigger date for the sequester of automatic spending cuts totaling $1.2 trillion over nearly a decade from January 1 to March 1, expect renewed debate to begin with the start of the 113th Congress on a long-term plan for deficit reduction. By most estimates, the U.S. government will reach its $16.4 trillion borrowing limit by the end of February – so wrangling will also renew the debt ceiling, entitlement reforms, and spending cuts. Additionally, the federal government is set to shut down on March 27 unless Congress authorizes a continuing spending resolution. This could set up either an additional catalyst for a broader brinksmanship scenario or yet another moment in a series of showdowns that continue from last year.
Prospects for comprehensive tax reform and entitlement reform remain uncertain, with both sides appearing unwilling to reach meaningful compromises without an imminent deadline with severe consequences. Since Congress is now likely to be consumed by a series of short-term budget battles, such partisan bickering may distract lawmakers from the complicated process of achieving comprehensive tax and entitlement reform.
Summary of Other Key Real Estate Provisions
What possible changes could hurt your current business or future opportunities?
- Carried interest will continue to track the capital gains rate.
- Estate tax: The current $5 million per-person estate tax exemption remains (with the $5 million indexed for inflation), but the rate is increased to 40% from the current 35%.
- Bonus depreciation: This provision extends the current 50% expensing provision for qualifying property purchased and placed in service before January 1, 2014 (before January 1, 2015 for certain longer-lived and transportation assets) and also allow taxpayers to elect to accelerate some AMT credits in lieu of bonus depreciation.
- 15-year straight-line cost recovery for qualified leasehold improvements on commercial properties is extended through 2013 and made retroactive to cover 2012.
- 7-year recovery period for motorsports racetrack property: The law extends for two years, through 2013, the special seven year cost recovery period for property used for land improvements and support facilities at motorsports entertainment complexes.
- Alternative Minimum Tax (AMT) is patched permanently.
Make It To Midyear
Make your voice heard on issues affecting the commercial real estate industry and your clients by joining thousands of other REALTORS® at the 2013 Midyear Legislative Meetings in Washington, DC from May 13th-18th. You have the opportunity to meet with elected representatives as part of official Capitol Hill visits, and experience firsthand the strength of the collective voice of the National Association of REALTORS®. There is no fee to register for NAR Members; this conference is a benefit of your membership!
Engage & network with other commercial practitioners and leaders during the week at these key meetings:
Real Estate Issues in the 113th Congress: Federal Legislative & Political Forum
- Federal Priority Issues Briefing
- Commercial Committee Meeting
- Commercial Legislation & Regulatory Advisory Board
- Commercial Real Estate Research Advisory Board
- Commercial Economic Issues & Trends Forum
- Property Management Forum