Changes in Capital Gains Tax Rates in 2024

Changes in Capital Gains Tax Rates in 2024: What Real Estate Investors Need to Know

As we step into 2024, real estate investors, landlords, flippers, and syndicators face critical tax changes that could significantly impact their bottom line. One of the most pressing concerns is the potential adjustment to capital gains tax rates. Understanding these changes is vital, whether you’re buying, holding, or selling property.

For seasoned investors, capital gains tax has always been a crucial consideration when selling properties. However, with the anticipated tax changes in 2024, the stakes have gotten higher. In this article, we will explore what capital gains taxes are, the proposed changes, how they might affect different categories of real estate investors, and strategies to mitigate the impact.

What Is Capital Gains Tax?

Capital gains tax applies to the profit made from the sale of assets, including real estate. When you sell a property for more than its purchase price, the difference (profit) is considered a capital gain, and you are taxed on it.

There are two types of capital gains:

1. Short-term capital gains (for assets held less than a year), taxed at the seller’s ordinary income tax rate.

2. Long-term capital gains (for assets held more than a year), taxed at preferential rates, which are typically lower than ordinary income tax rates.

For the 2023 tax year, long-term capital gains were taxed at 0%, 15%, or 20%, depending on income levels. High-income earners may also be subject to a 3.8% Net Investment Income Tax (NIIT).

What Changes in Capital Gains Tax Are Proposed for 2024?

There has been considerable discussion regarding potential tax policy changes for 2024 that could affect capital gains. While no final legislation has been passed as of yet, here are some key proposals and expectations:

1. Increase in Long-Term Capital Gains Rates: Currently, long-term capital gains benefit from lower tax rates. However, some lawmakers have proposed increasing the top capital gains rate for high-income individuals from 20% to potentially 25% or more. This change could apply to individuals with an income over $1 million, but even middle-income investors could see shifts in their tax rates depending on how the law is structured.

2. Changes to the 3.8% NIIT: There is discussion around expanding the 3.8% NIIT to a broader base of income, which could include more real estate-related income beyond just passive investment income. This would increase the overall tax burden on real estate investors.

3. Elimination of Tax Benefits for Carried Interest: Carried interest, which benefits syndicators and those working in private equity or real estate partnerships, has long enjoyed favorable tax treatment. In 2024, there are renewed efforts to close the carried interest loophole, which allows investment managers to pay capital gains tax rates (instead of ordinary income rates) on their profits.

How These Changes Affect Different Types of Real Estate Investors

The anticipated changes in capital gains taxes will impact various stakeholders in the real estate sector differently. Here’s a breakdown of how these changes could affect landlords, property syndicators, flippers, and wholesalers:

Landlords:

Landlords, especially those holding properties long-term, may face increased taxes when they sell. If long-term capital gains tax rates increase, landlords could owe more when liquidating properties they’ve held for years. Additionally, landlords nearing retirement or considering downsizing may face an unexpected tax hit if the NIIT is expanded.

Syndicators:

Real estate syndicators, who pool investor capital to acquire large properties, might feel the greatest impact. Not only could they face higher taxes on their share of capital gains from property sales, but changes to carried interest could significantly reduce their take-home profits. Syndicators may need to restructure deals to account for higher taxes, potentially offering less attractive terms to investors.

Flippers:

Property flippers, who often rely on short-term capital gains, are already taxed at higher ordinary income rates, but any changes to overall income tax brackets or the NIIT could also affect their profits. Additionally, some flippers might consider holding properties longer to benefit from long-term capital gains rates, but an increase in those rates might reduce the attractiveness of this strategy.

Wholesalers:

For wholesalers, capital gains tax isn’t typically as large of an issue since they focus on short-term real estate transactions (assigning contracts). However, if wholesale profits are viewed as investment income, they might be subject to new tax rules or NIIT adjustments.

Strategies to Mitigate Capital Gains Tax Increases

As tax rates rise, real estate investors must plan carefully to minimize their tax liabilities. Here are a few strategies that investors should consider to mitigate the impact of potential capital gains tax increases:

1. Use a 1031 Exchange: One of the most effective tools for deferring capital gains tax is the 1031 exchange, which allows investors to defer paying taxes by reinvesting the proceeds from a sale into a like-kind property. While the 1031 exchange is still a viable strategy in 2024, there have been discussions about limiting this benefit. Investors should act quickly before any changes take effect.

2. Hold Properties for Longer: While the risk of rising long-term capital gains rates might encourage some investors to sell sooner, holding onto properties might still be a smart strategy. Real estate, as a tangible asset, typically appreciates over time, and other tax incentives (such as depreciation and interest deductions) can offset holding costs.

3. Offset Gains with Losses: Investors can use tax-loss harvesting to offset gains. If an investor has a property or another investment that has lost value, selling it to realize a loss can offset the capital gains from profitable property sales, lowering the overall tax burden.

4. Timing Matters: Timing the sale of a property can help investors take advantage of lower tax rates in a given year. For example, if legislation is expected to increase capital gains rates starting in 2025, investors may benefit from selling in 2024 under the current tax rates.

5. Opportunity Zones: Real estate investors can also explore investing in Opportunity Zones, which offer significant tax benefits, including deferrals and potential exclusions of capital gains for investments held for extended periods. These zones are designed to encourage investment in economically distressed areas.

6. Invest in Real Estate Investment Trusts (REITs): REITs offer a tax-efficient way to invest in real estate without direct ownership. Dividends from REITs are typically taxed at ordinary income rates, but investors can avoid the complexities of capital gains taxes on direct property sales.

Conclusion: Preparing for Capital Gains Tax Changes in 2024

The proposed capital gains tax changes in 2024 have the potential to impact real estate investors significantly, particularly those who depend on profits from the sale of long-term holdings. Investors must be proactive in planning their tax strategies, considering the best times to sell, and exploring options like 1031 exchanges and Opportunity Zones.

Whether you’re a landlord, flipper, syndicator, or wholesaler, the key takeaway is that tax planning should not be an afterthought. With possible changes on the horizon, now is the time to consult with tax advisors and prepare for the potential increase in capital gains taxes. By understanding the new landscape and employing effective strategies, investors can protect their profits and continue to build wealth through real estate.