Amid economic concerns post-2020 and into 2022, the layout of the U.S. population is shifting. While the national population growth rate for 2021 was only .1%, the number of Americans moving across state lines has risen.
A significant factor in increasing interstate migration is the high-income tax rate in some states. Let’s explore how state income tax rates affect state populations and what this could mean for future real estate investing.
Structure of State Income Taxes
State income tax provides each state with a significant source of revenue to fund public programs and projects. Each state sets its own tax rate, with some states using a flat-income tax rate or a graduated rate.
Forty-three out of 50 states and the District of Columbia collect income tax from their residents using these structures. By comparison, eight states, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming, do not levy income tax on individuals living in the state.
New Hampshire and Washington tax differently than most states. New Hampshire taxes interest and dividend income, while Washington taxes capital gains for those earning more than $250,000 annually on their investments.
Population Shifts Due to Low State Income Tax Rates
In 2021, the U.S. saw sizable population growth for some states. According to the U.S. Census Bureau, Idaho, Utah, Montana, and Arizona saw the highest population growth, with Texas and Florida not far behind. Idaho’s population grew 2.9%, from 1,839,106 to 1,900,923 in just one year. Texas’ population grew 1.1%, and Florida saw a population growth of 1.0% in the same period.
When connected with income tax rates and proximity to high-tax-rate states, the population increase in these states is not surprising. Utah and Arizona have income tax rates of 4.95% and 4.50%, respectively, while Idaho sits at 6.00% and Montana at 6.75%. Both Texas and Florida are no-income-tax states and are seeing high economic growth from booming businesses.
High State Income Tax Rates and Population Decline
Many highly populated states saw outbound migration and population decline in 2021. Topping the list are the District of Columbia at -2.9%, New York at -1.6%, Illinois at -0.9%, and California and Hawaii both at -0.7%. California lost over 300,000 residents, and New York saw 365,336 people move out of the state.
Although many factors play into population decline, high state income tax rates are a likely culprit. Of the states with the most significant population decline, all but one top the list of highest state income tax rates in the country.
California is the highest at 13.30%, while New York and DC come in at 10.90% and 10.75%, respectively. Hawaii also has a high state income tax rate of 11.00%. Surprisingly, Illinois’ income tax rate is only 4.95%, pointing to other contributing factors.
How Population Shifts May Affect Real Estate Investing
If you are thinking about investing in real estate, state income tax policies and population shifts may influence your decisions. States like Florida and Texas see high population growth and don’t require you to pay a state income tax.
Investing in a piece of property in these states can work in your favor because you can pocket the profits of your rental income rather than increasing your tax bracket. You also don’t have to worry about adding capital gains to your income for tax purposes in these states when it’s time to sell your property.
However, some states, like Washington, tax capital gains on high dollar earners. Before investing, consider each state’s capital gains tax rate and the state income tax rate.
If you live and invest in areas with high capital gains taxes, think about the possibility of a 1031 Exchange as a wealth management strategy. Using this option allows you to defer capital gains taxes on the investment property you’re selling by exchanging the proceeds to invest in a property of equal or higher value.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.