NMHC/NAA Viewpoint: The Biden Administration’s proposal to tax certain unrealized capital gains at death could diminish or discourage the ability of heirs to make improvements to inherited property, including affordable housing, or to make other productive investments.
Given that many apartment firms are small businesses, often family owned, the transfer of assets to heirs is a major consideration for company principals. While the estate tax may apply to a decedent if the estate value exceeds the exemption amount, current law appropriately enables the heirs to receive property with a basis stepped up to fair market value at the time of the decedent’s death. This is particularly important for the apartment industry because many industry executives’ estates include significant amounts of depreciable real property.
To illustrate how present tax law works, consider the following example: An individual purchased an apartment property in 1996 for $7.5 million before passing away in 2024 and transferring the property to an heir. At the time of transfer, the property is worth $22.5 million and, due to improvements of $3 million and depreciation of $9 million, has a tax basis of $1.5 million. The property has an operating income of $1.575 million.
Currently, the $1.5 million in tax basis would be stepped-up to $22.5 million. Tax would only be imposed when the heir sells the asset and would be based on the difference between the sales price and the $22.5 million in tax basis (including any adjustments such as improvements and depreciation).
Unfortunately, the Biden Administration is proposing to impose tax on gain when property is transferred by gift or at death, which effectively eliminates the step-up in basis under current law, subject to a $5 million individual exclusion amount allowed under the proposal. In the example, above, a capital gain of $16 million would be realized when the property is passed to an heir. (This is calculated as $22.5 million in fair market value, less $1.5 million in basis, and less a $5 million exclusion.) The $16 million capital gain would be subject to a 25-percent tax on the depreciation recapture and capital gains tax on the remainder of the gain. This would far exceed the building’s annual operating income. Notably, if other Biden Administration proposals were also enacted, including those increasing capital gains tax rates, raising the rate of and expanding the net investment income tax to encompass all capital gains, and taxing depreciation recapture at ordinary income tax rates, the tax on such a sale would be prohibitive.
If enacted, this proposal would have extremely unfortunate consequences. Not only would death become a taxable event with an exclusion amount far below today’s estate tax exclusion of $13.61 million per person, but funds necessary to pay the tax may have to be deferred from beneficial uses, namely maintaining and improving housing.
While the Biden Administration proposes ostensible relief for illiquid assets, these options only delay the inevitable. Under one option, taxpayers would have 15 years to pay the tax. However, this would mean that a substantial portion of a property’s operating income would have to be committed to paying this tax, leaving less capital to improve and upgrade the property (in addition to paying current-year income and property taxes attributable to the asset). This could negatively impact the amount of affordable housing in the marketplace.
Under a second option, family-owned and operated businesses could defer tax until a property is sold. While tax may not be immediately due, the lingering prospect of a significant tax bill upon sale (i.e., the deferred tax plus potential additional taxes on gains incurred after the transfer) could deter an heir from making a sale to invest in other assets, such as affordable housing, or multiple heirs who may wish to start new ventures.
The Biden Administration is seeking to effectively make death a taxable event at a level that is less than half of today’s estate exemption.
