How the Biden-Harris Admin Would Close Tax Loopholes

The U.S. tax landscape is poised for significant changes with the presidential election in November. The Biden-Harris admin suggested a variety of changes in their tax plan proposed closing loopholes such as carried interest, like-kind exchanges, depreciation recapture, and airplane depreciation.

If V.P. Harris is elected in November, you can expect to see the new President push for these reforms.

Here’s a breakdown of the proposed changes:

Carried Interest

Under current U.S. tax law, partnerships do not pay federal income tax.

Instead, their income or losses flow through to the partners, who report these amounts on their tax returns. Some partners receive interests in future profits, known as “carried interests,” for services provided, which are taxed at lower long-term capital gains rates.

The current law extends the holding period for some capital gains from one year to three years under Section 1061 of the Internal Revenue Code. However, income from profits interests is typically subject to self-employment tax, with certain exclusions.

The proposed changes aim to tax income from “investment services partnership interests” (ISPIs) as ordinary income if the partner’s total income exceeds $400,000.

This income would no longer qualify for reduced capital gains rates and would be subject to self-employment taxes. The proposal seeks to prevent income from labor services from being taxed at the lower capital gains rates and includes measures to reclassify gains from ISPI sales as ordinary income if the partner exceeds the income threshold. It also introduces anti-abuse rules to prevent the use of other compensatory arrangements to bypass these rules.

These changes, effective from January 1, 2025, are intended to ensure that service-related income from partnerships is taxed similarly to wages, promoting fairness in the tax system.

1031 Exchanges

Owners of appreciated real estate used in a trade, business, or for investment can defer taxes on capital gains by exchanging the property for another of a similar type, known as a “like-kind” exchange.

This deferral lasts until a later taxable event occurs.

The proposal aims to treat real estate exchanges similarly to sales, thereby reducing tax distortions. It seeks to raise government revenue and enhance the tax system’s progressivity by treating real property consistently with other types of assets.

The proposed change would cap the deferral of gains at $500,000 per taxpayer per year (or $1 million for joint filers) for like-kind exchanges. Any gains exceeding these amounts in a given year would be taxable in the year the exchange occurs. The change would take effect for transactions completed in taxable years starting after December 31, 2024.

Depreciation Recapture

When disposing of depreciable real property, taxpayers may recognize gains or losses.

Gains attributable to previously claimed depreciation deductions are often recaptured as ordinary income, particularly for personal property under Section 1245.

However, for real property under Section 1250, only the excess depreciation over straight-line depreciation is recaptured. Most gains from real estate are taxed at capital gains rates, which are generally lower than ordinary income rates.

Currently, noncorporate taxpayers benefit from lower tax rates on gains from the sale of real property used in business, as these are often taxed at capital gains rates rather than ordinary income rates. This provides a tax advantage by allowing the conversion of ordinary income into capital gains, especially benefiting real estate businesses.

The proposal aims to fully recapture depreciation deductions as ordinary income for Section 1250 property (depreciable real property), thus taxing gains at ordinary income rates instead of capital gains rates.

This rule would apply to depreciation deductions taken after the effective date and not to noncorporate taxpayers with an adjusted gross income below $400,000 ($200,000 for married individuals filing separately). The proposal would be effective for taxable years beginning after December 31, 2024.

Airplane Depreciation

The current depreciation rules allow for a five-year recovery period for airplanes not used in commercial or contract passenger and freight services, including corporate jets, while those used in commercial services have a seven-year period.

The proposed change aims to harmonize these periods by defining “general aviation passenger aircraft” as planes primarily carrying passengers but not used commercially.

The proposal extends the depreciation period for these planes from five to seven years, and from six to twelve years for those using an alternative system. Exceptions include planes for non-passenger activities, like crop dusting or firefighting, which maintain a five-year period. The changes would apply to properties placed in service after December 31, 2024.

Conclusion

These proposed tax reforms are designed to enhance equity and efficiency in the U.S. tax system.

By addressing carried interest, like-kind exchanges, depreciation recapture, and airplane depreciation, the changes aim to ensure a fairer distribution of tax burdens and remove preferential treatments.