Assessing The Impact Of Tax Reform On The Real Estate Market
The Tax Cuts and Jobs Act (TCJA) has impacted a lot of different entities in different ways. This year, as we prepare and file 2018 tax returns, we will get to see how all the changes truly stack up.
What we do know is that the tax reform legislation, which was passed in late 2017, represented an important victory for those in the commercial real estate industry. For many years, the debate surrounding tax reform gave rise to ideas that many thought would have resulted in long-term damage to the real estate industry as a whole. Specifically, preliminary conversations concerned the elimination of 1031 like-kind exchanges, ending capital gains tax treatment for real estate carried interests and not allowing deductibility for interest payments on the financing for real estate projects, resulted in a lot of sleepless nights.
The legislation that followed, however, put a lot of minds at ease. The following is a list of “wins” for those in the real estate arena – followed by a few “losses.”
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Tax Incentives Still Exist
- The TCJA preserved Section 1031 like-kind exchanges for real estate, which is regarded as a major industry tax break, effectively allowing deferral of paying taxes by trading in old real estate for something new.
- The legislation created a three-year holding period for long-term capital gain treatment with regard to carried interests for certain kinds of partnerships, including real estate.
- It was decided that favorable depreciation will continue on.
- The deductibility of business interest expense for real estate trades or businesses was preserved.
- The bill resulted in the reduction of the tax rate for many pass-through businesses, including many in real estate, making the effective maximum rate 29.6 percent.
- Corporations received the gift of a new 21 percent tax rate (down from 35 percent), which also repealed the corporate alternative minimum tax.
- The TCJA retained the New Markets Tax Credit program, which incentivizes business and real estate investment in low-income communities.
- The 20 percent Historic Tax Credit was retained, albeit with modifications. Instead of being able to immediately claim the credit, it must be claimed over a period of five years. Moreover, the non-historic credit of 10 percent for pre-1936 buildings was repealed.
- The legislation retained the low income housing tax credit, a dollar-for-dollar tax credit that incentivizes private equity in the development of affordable housing, without modification.
- The tax-exempt status of Private Activity Bonds was retained.
- While subject to thresholds and limitations, the Qualified Business Income Deduction offers pass-through entities a 20 percent tax deduction.
- Estate Tax Exemptions were doubled as a result of the TCJA. Prior to the tax reform legislation, exemptions were $5,490,000 for individuals and $10,980,000 for couples. Under the new bill, exemptions for 2018 were increased to $11,180,000 for individuals and $22,360,000 for couples. In 2019, these exemptions increase to $11,400,000 and $22,800,000.
- Opportunity Zones were created with TCJA and are designed to spur economic development by providing tax benefits to investors. Investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or Dec. 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10 percent exclusion of the deferred gain. If held for more than 7 years, the 10 percent becomes 15 percent. If the investor holds the investment in the Opportunity Fund for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged. Certain rules apply and must be strictly followed.
Listen to episode 162, “If You Build It, The Will Come,” on Rea & Associates’ award-winning podcast, unsuitable on Rea Radio, featuring Doug Houser, Rea’s director of construction and real estate services.
As it stands, there are still a lot of incentives out there for investors, developers and others who might be looking to take advantage of the tax incentives that exist in the real estate arena. At the individual level, on the other hand, even though individual tax rates saw a reduction, so did the cap on home mortgages – which is now $750,000, down from the previous cap of $1 million. Moreover, the itemized deduction for taxes is now limited to $10,000 and interest deductions for home equity lines were eliminated unless the money is used for capital improvements to the home and falls within the home loan debt limit.-
At this point in time, we don’t foresee any hiccups in the near future, but we will keep you posted. If you would like to learn more about the great tax incentives available to those in real estate, give me a call or feel free to email another member of our construction and real estate services team.
By Judy Mondry, CPA, CVA (Cleveland office)