Updated: Jul 14, 2019
New Tax Law: A Win for Commercial Real Estate
If you’re not already investing in commercial real estate, maybe you should be. The Tax Cuts and Jobs Act of 2017, signed into law last December, represents the most significant and sweeping US tax reform of the last 30 years and is generally viewed as a big win for the commercial real estate (CRE) industry. While it may take years to see the law’s full effects, certain new provisions will have substantive impact on the CRE industry. Furthermore, most tax benefits for the industry pre-existing the act have been preserved under the new law. This combination means a boom for CRE owners and investors, including those involved with real estate investment trusts (REITs).
One of the biggest changes under the new law is the pass-through deduction. Under Section 199A, entities organized as partnerships, limited liability companies, or S Corporations can deduct up to 20% of their qualified business income. Although it is complex, subject to many limitations, and ends after 2025, this provision has huge savings potential for savvy CRE investors who are eligible. It also raised a lot of questions. Immediately after its enactment, industry insiders warned that the IRS would need to issue additional regulations to help clarify the new provision. The IRS announced these proposed regulations early last month in a 184-page document. While not yet final, investors should rely upon the proposal for additional guidance related to Section 199A until final regulations are issued.
This new deduction includes income that passes to REIT investors through dividends, effectively also lowering their overall tax rate. That means, according to Nareit (formerly the National Association of Real Estate Investment Trusts), that shareholders who previously were paying 39.6% on their dividends would now have a significantly lower rate of 29.6%, keeping REITs attractive options for investors and possibly fueling demand for shares.
The new law also includes many changes to the depreciation and expensing rules. While previously only able to claim 50% bonus depreciation, property owners can now expense the full cost of certain qualified properties. Eligibility requires that the property have a depreciable life of less than 20 years and that it must be the first use by the owner. Used property is now also eligible, as long as it’s the first use by the new owner.
Savings for the CRE industry are also found in the drop of the corporate tax rate from 35% to 21%, the repeal of the corporate alternative minimum tax, and the ability to deduct mortgage interest in full on commercial properties in the year of acquisition.
Yet another big win for CRE owners and investors was the act’s upholding of existing tax benefits such as the historic preservation and rehabilitation tax credit and the 1031 exchange. Under the latter, also known as a “like-kind exchange,” capital gains taxes on the sale of a property can be deferred if reinvesting the proceeds in another similar property (which meets IRS like-kind criteria). There is no limit on the number of exchanges, and no tax is paid until the final sale occurs. Under the new law, real estate is now the only asset that can still use this tax-deferral mechanism.
To fully understand how the new tax law impacts you and your business, contact a qualified tax professional or look for more information on IRS.gov or the Urban-Brookings Tax Policy Center at taxpolicycenter.org.