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Why is the Tax Cuts and Jobs Act a significant win for the commercial real estate industry?
While the future effects of the recently passed Tax Cuts and Jobs Act have yet to be experienced, these changes are expected to promote economic growth, fuel job creation, and have many positive impacts in the commercial real estate industry.
The following is a summary of some of the major provisions affecting commercial real estate and real estate professionals:
Reduced Corporate Tax Rate
The Act reduces the highest corporate tax rate from 35% to 21%—the lowest percentage that assessment has been since 1939. The decreased corporate tax rate has already triggered announcements from many companies, including American Airlines, Apple, Boeing, Bank of America, JPMorgan Chase, and Wells Fargo handing out bonuses, raising minimum wages, or increasing 401(k) matching—all ways to divvy some of their windfalls with their employees. Americans for Tax Reform compiled a list of 262 companies so far, that named some financial benefit for workers resulting from the tax cut. Three Houston-area companies were on the list: Cabot Oil & Gas Corporation; Camp Construction Services; and Group 1 Automotive.
Entities structured as pass-through businesses such as sole proprietorships, partnerships, limited liability companies, S corporations, real estate companies, hedge funds, and private equity funds, will pay a top individual rate of 37%. Additionally, the pass-through business income will be eligible for a 20% deduction. Together, these provisions could lead to a maximum rate of 29.6% on business income, much lower than the current 39.6%. The 20% eligibility affects business owners with incomes higher than $157,500 for singles or $315,000 for joint filers. As a result of these deductions, the likelihood of major new development in many property sectors will increase.
The Act leaves the tax treatment provided for carried interests basically unchanged. A carried interest is a financial interest in the long-term capital gain of a development. For example, the carried interest is given to a general partner, usually the developer, by the limited partners—the investors in the partnership. To receive long-term capital gains treatment, any gain capable of being allocated to the carried interest must be the result of assets held for more than three years.
Section 1031 Like-Kind Exchanges
The tax reform legislation will maintain Section 1031 like-kind exchanges for real estate, modifying provisions by narrowing their application to real property that is not held primarily for sale. Therefore, appropriately arranged real property exchanges will continue to have tax-deferred treatment. However, the portion of any exchange that includes personal property will no longer qualify for tax-deferred treatment.
Future Effects of Tax Reform
The continuation of the existing tax benefits of real estate investment alongside gains from the new tax reform should work together to strengthen the economy through a stronger workforce, healthier bank sector, and positive effects to the commercial real estate industry. Lowering the tax rate for corporations, reducing the tax rate for pass-through businesses, continuing the preferential long-term capital gains tax rate, and like-kind exchange tax-deferral treatment, to name a few, could prompt major new development in many property sectors. With caution not to overbuild—and responsible lending—developers, lenders and brokers (and their clients), could benefit as decisions are made in 2018 and beyond.
Disclamer: NAI Partners does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
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