While a healthy chat about politics is not uncommon in commercial real estate and investment circles, the focus when the presidential race comes up every four years is often robust and focused on which candidate will do what with capital-gains tax.
Capital-gains tax is a federal tax applied to profits, of course. For real estate, the rate is 15 percent today for folks over the 25 percent income tax bracket. Most investors are versed in a deferral mechanism called the 1031 Exchange, where if you sold an investment property for profit, you could park the proceeds from the sale with a third-party intermediary called an exchange facilitator and use these proceeds to buy another investment property of equal or greater value. You keep deferring the capital-gains taxes until you stop this process and keep your profits. Except for this mechanism, though, when you make a profit, the capital-gains tax is due the year the property is sold.
Part of the debate is philosophical. Some view capital gains as an unfair double tax. The income you earned to buy the rental property was taxed once, goes this view, and it would be unfair to tax profits you earn again after putting that money at risk in an investment. On the other end, real estate investors often are viewed as the wealthy of our country — and many are — and that is justification to increase the rate. It’s a great debate.
Early in his presidential campaign, U.S. Sen. John McCain said he’d veto any tax increases proposed from Congress, noting that an increase now would be worse for our economy. Sen. Barack Obama, by contrast, has made his position clear that the wealthy will pay more taxes if he wins the post, and the capital gains rate would go up. He has proposed the highest capital-gains rate. Sen. Hillary Clinton is also a supporter of a higher capital-gains rate, just not as high as Obama’s.
There is a paradox of human behavior that brings us right back to day-to-day life and often determines where one stands on capital-gains tax. Move the capital-gains rate over a certain threshold and investors just won’t sell. That makes sense when viewed on an individual transaction basis: If there isn’t enough profit after paying capital-gains taxes to make a buyer’s offer worthwhile to accept, there’s no incentive to sell. Keep the rate under a certain level and people transact more properties. From a public policy standpoint, politicians run the risk of actually reducing total revenues from this source when they increase the rate. That’s why it’s a great discussion.
In fact, a 1995 study by DRI/McGraw-Hill is one of many which confirm this phenomenon. The study concludes that “lower capital costs induce more investment, faster productivity growth, higher gross domestic product (GDP) and increased employment. The capital-gains tax reductions also cause the price of capital assets to increase and the stock market to rise in value. In addition, total federal tax revenues would increase relative to the baseline forecast.”
Real estate investors are looking closely at this year’s presidential race and forecasting their best guess on the outcome into their investment decisions this year. Some who expect an Obama or Clinton win are moving quickly to sell now under today’s presumed lower rate. Some are choosing to pull their property off the market and not sell in hopes that the rate will come back down again after another presidential cycle. Investors anticipating a McCain win seem more willing to stick with their plans and transaction decisions, continue with new investment, and generally advance their plans based on factors other than the capital-gains tax.
Tom Hoban is CEO of Coast Real Estate Services, a commercial sales, leasing, investment and property management company with offices in Everett, Tacoma, Spokane and Boise, Idaho. He can be reached at 425-339-3638 or send e-mail to tomhoban@coastmgt.com.
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