New Year, New Taxes
2012 saw a continued improvement in the US commercial real estate market in general, with Multifamily Apartments maintaining its status as the darling asset class. We are happy to note that development activity is increasing in a sure sign of an improving market with tightening supply. Single Family and Condo sales are also improving, with certain markets showing a severe undersupply of inventory For example, the high-end Condo market in Boston's Downtown & Back Bay only has a three month supply of inventory, six months supply being considered the market equilibrium.
Having just passed the overhyped "Fiscal Cliff" be prepared for the next media onslaught as we approach the "Debt Ceiling". This will no doubt require last minute negotiations and compromises as we are brought back to the perceived brink once again.
With the New Year comes the enactment of many new laws, one of which directly impacts US investors in the form of a new surtax. This will have a particular impact on real estate investors that are considered "passive investors", that is, they do not spend the majority of their working hours on a real estate business. Therefore the new tax has no impact on individuals working full-time on their real estate investments, and can prove they spend 500 hours a year on them, or real estate companies. As real estate lends itself very well to the passive investor, and given that real estate offers an excellent return on investment, this tax is likely to impact a large percentage of US taxpayers.
The surtax was part of the Affordable Healthcare Act passed in 2010, to be used to pay for Medicare. The surtax will only impact higher income individuals, those earning $200,000 as individuals, or $250,000 if married. The surtax rate is 3.8% on one's net investment income, which includes the net real estate income and the net realized capital gain in a given year. The tax code applies the surtax to the lesser of the actual net investment income, or the amount that your total adjusted gross income exceeds the $200,000/$250,000 threshold.
It is unlikely that this new surtax will have a large enough impact on investors, or their net returns, to negatively impact the appetite for investment real estate. After all, real estate is an attractive investment asset class producing good investment yield, while also hedging against inflation.
There has not yet been a definitive definition given of the new legislation's Net Investment Income, although it's generally taken to mean "unearned income" such as rents, dividends, interest, capital gains, royalties, etc. Also not clearly defined is the treatment of certain allowable deductions against Net Investment Income. Therefore as always one should refer to an expert tax professional for advise on their own particular situation. I would be happy to make a referral to such tax experts.