WASHINGTON, D.C. — As the much anticipated tax reform legislation makes it way through Congress, commercial real estate investors may be wondering what reverberations they will feel if the proposed changes are signed into law by President Trump.
According to a special report by Marcus & Millichap, the two final versions of the law from the U.S. House of Representatives and Senate appear relatively benign for real estate investors.
Both versions of the legislation, which have yet to be reconciled, offer modest changes to key provisions including 1031 tax-deferred exchange, mortgage interest deductibility and asset depreciation.
The tax plans offer generous cuts for corporations and pass-through entities such as limited liability companies, which may lend an opportunity for investors to reconfigure their portfolios.
“There are many nuances in both the House and Senate versions,” says John Chang, first vice president of research services at Marcus & Millichap. “The House version could reduce tax rates on this income from personal rates as high as 39.6 percent to as low as 25 percent depending on whether the earnings are active or passive. The Senate version grants a 23 percent deduction on qualified pass-through income with some restrictions.”
The maximum tax rate for corporations reduced from 35 percent to 20 percent under both versions of the legislation. Individual tax rates, however, vary greatly between the House and Senate; with the House creating four tax brackets and the Senate creating seven.
“Personal tax rates and tax brackets vary significantly between the House and Senate versions but generally go down for most top-tier income segments,” says Chang. “However, changes to the tax structure for pass-through entities that allow tax rates as low as 25 percent may create significant benefits for private investors to move assets held as personal holdings into a pass-through entity.”
The House and Senate legislation make no changes to the real estate portion of tax-deferred exchange rules. Under the House, the deduction of interest on real estate would also be unchanged for real estate businesses. The Senate, however, allows full deduction but extends depreciation timelines if the deduction is used.
The current 27.5-year depreciation term is upheld in the House version of the proposed tax legislation, while the Senate version increases the time of depreciation term to 30 years if interest deductibility is used, but offers a 25-year depreciation period if no interest deduction is taken.
The hold time of assets is increased from one year to three years in both versions of the legislation to treat earnings as capital gains.
“For the commercial real estate sector, one of the greatest benefits of the new tax law could simply be its finalization, as this will reduce uncertainty,” says Chang of Marcus & Millichap. “With new tax rules in place, some of the caution that emerged over the last year could abate, reinvigorating investors who moved to the sidelines over the last year. ”
Chang also notes that the tax rules could favor rental housing, while placing a modest damper on student housing demand.
“The House version of the plan would begin taxing graduate student tuition reductions as income,” he says. “Some graduate students work at their university and receive tuition reductions instead of pay, and the new tax laws would effectively raise costs for students pursuing advanced degrees.”
Healthcare real estate is another sector that Chang feels could see ripples from the new tax rules.
“Two provisions could impact healthcare-related real estate such as medical office buildings and seniors housing,” he says. “The potential elimination of tax-free Private Activity Bonds (PABs) that are used to fund development of public interest projects like public seniors housing facilities could reduce construction of healthcare real estate.”
“Another factor emerges under the Senate version: the elimination of the personal mandate,” Chang continues. “The elimination of this provision of the Affordable Care Act could reduce the number of insured by an estimated 13 million people by 2027. This change could reduce demand for medical services and seniors housing by as much as 5 percent over the next 10 years.”
The proposed tax legislation will continue to change as both versions go through reconciliation between the House and Senate.
“Moderate differences between the House and Senate versions could take time to align with sticking points arising over the deductibility of state and local taxes and the cap on mortgage interest deductions for owner-occupied housing,” says Chang. “Congress appears committed to finalizing the new tax code and delivering it to the president for his signature before the end of the year.”
— Katie Sloan