President Trump signed the new Tax Cuts and Jobs Bill on Dec. 22, effectively putting the final seal of approval on the most substantive tax law changes that the country has seen in 30 years.
It may take some time to crunch the numbers to determine just how much tax savings the new tax bill could generate for commercial real estate investors. The general view is that provisions specific to property owners and developers will deliver a net positive result.
- CRE investors gain more tax savings from multiple provisions in the new bill
- Pass-through income is taxed differently, allowing more deductions
- The 1031 exchange rules still allow investors to defer capital gains on sale if they reinvest
- Low-income housing tax credits are preserved in the new bill
Pass-through income – Potentially, one of the biggest “wins” in the tax bill for real estate will be changes to the way pass-through income is taxed. The change would mainly apply to individuals and family trusts investing in real estate through partnership entities, such as LLPs and private equity funds, as well as individuals who receive income from REIT dividends.
Owners of pass-through entities may be eligible to claim a 20 percent deduction for business-related income. For example, if an LLP owns an office building that provides $200,000 in annual income to its investor partners, those individual investors could avoid paying taxes on $40,000 of that income if they are eligible for the full 20 percent deduction.
1031 Exchanges – The tax bill preserves the 1031 tax-deferred exchange rules that allow investors to defer capital gains on the sale of a property by reinvesting proceeds into another qualifying “like-kind” property. One key change in the new tax bill is that the 1031 exchange can only be used to defer capital gains on the value of real estate property and excludes any value on personal property.
Carried-Interest – Carried interest tax law has been under fire for more than a decade. Some view current carried interest tax laws as a loophole for hedge fund managers, allowing them to be taxed at lower capital gains rates rather than ordinary income rates. What ultimately passed as part of the new tax framework was a moderate provision that changes the hold period to qualify for the capital gains rate from one year to at least three years.
Tax Credits – Another important aspect of the bill is that it maintains the status quo for low income housing tax credits, as well as historic preservation and rehabilitation credits. “That is a positive for those segments of the real estate industry, and I would say that also is important from a socio-economic perspective, because a significant portion of the low-income housing development world is really tax-motivated,” says Trifilo. Change in Depreciation Schedules
Asset Depreciation – Businesses will be able to immediately expense the purchase of an asset. On the one hand, the quick cost recovery is a positive, because an investor is deducting an expense rather than recognizing taxable income, notes Bilsky. However, it could be a potential negative for REITs that are making distributions based on taxable income.
Some uncertainty lingers – To some extent, it may be too soon to tell how some of the different rules will play out. “There are a number of provisions where, realistically, we are going to need some more clarity,” Bilsky says. Added to that, most of the provisions do have a “sunset,” meaning they are not permanent and would either expire in 10 years or need to be extended by Congress. The fact that there is an end-date in sight also ensures that a shift in power in Congress in the next election is not likely to spark a battle to roll-back the new tax laws in a few short years, Bilsky adds.
View the original article at National Real Estate Investor