Navigating the Potential for Rising Tax Rates in the Next 5 Years

Tax Rates on the Rise for the Next 5 Years

Introduction

As we stand on the precipice of economic and political uncertainty, one topic that has gained significant traction in financial discussions is the possibility of rising tax rates over the next five years. While predicting future tax policy changes with absolute certainty is a daunting task, it’s important for individuals, businesses, and investors to be aware of the potential implications and take proactive steps to navigate this evolving landscape.

 

Economic Dynamics

The likelihood of rising tax rates is often influenced by broader economic conditions. Governments typically consider raising taxes during periods of economic strain, such as recessions, to generate additional revenue and manage deficits. In recent years, the global economy has faced challenges ranging from the COVID-19 pandemic to geopolitical tensions, all of which could contribute to a need for tax rate hikes.

Another key factor in the potential for rising tax rates is the prevailing fiscal policy and political climate. Government spending, social programs, and infrastructure investments are funded through taxes. As the needs of a society evolve, governments may find it necessary to adjust tax policies to ensure sustainable funding. Moreover, the political composition of legislative bodies can heavily influence tax policy decisions, with different parties prioritizing various fiscal approaches.

Governments must strike a delicate balance between funding essential programs and managing budget deficits. If expenditures outpace revenue, the pressure to increase taxes becomes more pronounced. Over the next five years, policymakers may face mounting pressures to address existing deficits or create room for new spending initiatives, potentially leading to higher tax rates across income brackets.

 

Potential Impact on Real Estate

One of the most impactful potential tax changes would be a revision to the capital gains tax structure. Capital gains tax is levied on the profit realized from the sale of an asset, including real estate. Changes to this tax could affect how investors perceive the profitability of real estate investments. For instance, an increase in the capital gains tax rate might prompt some investors to sell sooner in anticipation of rising tax rates.

If the 1031 exchange rules change, it might affect your exit strategies for existing properties. Consider how potential changes could impact your ability to defer capital gains taxes and plan accordingly.  If you’re contemplating selling a property and doing a 1031 exchange, you might want to consider whether it’s more advantageous to complete the exchange sooner rather than later, given the uncertainty surrounding potential changes.

Additionally, if an investor is leaving a high-tax state to move to a state with lower or no state income taxes, the issue remains with real estate investments still held in these high tax states.  Investors can utilize the existing 1031 exchange rules to convert this real estate, tax deferred, by utilizing a Delaware Statutory Trust (DST).  DST’s generally operate in low tax states, which potentially help investors avoid or reduce state income taxes on the DST investment income. 

 

Conclusion

While the potential for rising tax rates over the next five years is a topic of concern, it’s important to approach the situation with a balanced perspective. Governments face complex challenges in maintaining fiscal stability and funding essential programs. Individuals and businesses can proactively prepare for potential tax changes by adjusting financial plans, diversifying investments, and staying informed about economic and political developments. Ultimately, a thoughtful and strategic approach can help navigate the uncertainties of the evolving tax landscape.

 

Voss Real Estate Advisors

September 8, 2023

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