The Tax Cuts and Jobs Act (TCJA) was enacted in late 2017 with high expectations to create additional income for taxpayers, increase spending, and create jobs with the help of lower taxes for corporations.
Unfortunately, with great change comes great responsibility and commercial property users and owners should start familiarizing themselves with the new rules. Doing so can help increase their ability to claim the maximum deduction and avoid financial pitfalls.
Below, I briefly summarize some (out of the many) of the most important tax code changes which will impact commercial real estate (CRE) owners and users.
1. Like-Kind Exchanges | No Major Change
Background: Section 1031 of the Internal Revenue Code allows landlords to defer capital gains tax resulting from the sale of a property by using the proceeds to buy a “like-kind” business or property.
Before: There was some speculations that the Act would remove or limit the provision.
After: With the growth of businesses in mind, the provision was kept (but not for personal property and certain parts of the “gain” are no longer eligible for the exchange).
Impact: Businesses that own property can continue to be involved in the market because the provision makes it easier to trade commercial properties.
“These tax-deferred exchanges of property are critical to the real estate market from the perspective of providing increased liquidity as owners and investors look to lock-in the gains of an existing property by selling and then buying a ‘like’ property”
– Michael Haltman | Hallmark Abstract
2. Corporate Tax Rates | Reduced
Background: Lawmakers believed that a more favorable corporate tax rate structure was necessary for the United States to remain competitive with foreign countries.
Before: C-Corps paid graduated income-tax rates of 15%, 25%, 34% and 35%.
After: New flat 21% tax rate.
Impact: Lower corporate tax rate allows businesses to have more money left over to drive their growth and create jobs in the process. However, America’s economy continues to become more globalized and lower rates may not directly result in companies returning from overseas.
“There will [certainly] be more cash and profit to spend but most companies have been putting those tax savings towards increasing salaries, buying back shares, raising dividends to increase the short-term value of their companies.”
– Thomas Pham | General Certified Real Estate Appraiser
3. Pass-Through Entities | Deduction Increased
Background: The CRE industry is a big user of pass-through entities such as S-Corporations, trusts and estates, sole proprietorships, real estate investment trusts (REITs), and publicly traded partnerships (PTPs).
Before: Proceeds from these entities were treated as regular income on their owner’s personal taxes and can be taxed up to the individuals highest tax rate bracket.
After: A 20% deduction of “qualified business income” was enacted, which includes all domestic business income except investment income.
Impact: This rule has certain exceptions and wage limitations which makes it very complex. Appropriate planning is recommended to be eligible for the full 20% deduction as tax professionals are still waiting for new information to provide clearer details of the deduction eligibility.
“(Section) 199A sunsets as of January 1, 2026. Will Congress extend to make the pass-through deduction permanent? Or will Congress let the deduction lapse? […] So, its déjà vu all over again – come the fall of 2025 we once again will be peering over that dreaded fiscal cliff.”
– Christopher Rogers | Mitchell Williams Law (See The New Deduction for Pass-Through Income [or How Congress Failed at Tax Simplification]).
4. Estate Tax Exemption | Doubled
Background: Real estate values can increase considerably over time and that appreciation could leave family heirs with a hefty estate tax bill of 40%, often forcing them to sell the property.
Before: Previously exemptions were $5.49 M for individuals and $10.98M for couples.
After: Under the new bill, exemptions will double to $11M for individuals and $22M for couples for tax years 2018-2025. The step up in basis is also preserved.
Impact: The doubling of the Estate Tax Exemption helps investors pass their business or property on to the next generation with greater simplicity. It also allows small to mid-sized investors to grow and continue operating without immediate concern of a large estate tax bill.
“It’s critical for them to extend [the provision past 2025] because it certainly doesn’t help if they reduce it back to the original amount. Many would be forced to dissolve their estates and portion it out after operating under the higher limits for 7 years.”
– Michael Ambrosino – Ambrosino Consultant Corp.
5. Carried Interest Holding Period | Longer
Background: Simply, a real estate investment must be held for a certain period to receive preferential tax rates on carried interest (ie. Profits, interests, etc).
Before: Previously, the holding period was set at 1 year.
After: Any gain from the sale or other disposition of a carried interest (with respect to partnership interests held in connection with the performance of investment or development services [includes investing in and developing real estate]) will be long-term gain only if it is held for 3 years. Otherwise, carried interest would be taxed as short-term capital gains at a top marginal rate of 37%
Impact: Both President Trump and Hillary Clinton wanted to change the Carried Interest provision during the election and it was mostly targeted towards “managers of hedge funds and private equity funds” in the financial industry (although its reach may be broader).
“If there is a development project that sells really well, and the sponsor hasn’t met the new three year holding period for its carried interest, they can possibly utilize the proceeds in a 1031 Exchange in order to avoid having their gains treated the same way as ordinary income.”
– Matthew Rappaport, Esq., LL.M.
Overall, the Act is comprehensive and highly individualized. It becomes even harder to predict its outcome after taking changes to the individual tax code into consideration (increased standard deduction, limits on state tax deduction, etc.).
Will the modernized tax code be enough to sustain growth within the CRE industry? Unfortunately, we will not know until 2019.
Knowing your Commercial Property’s position in today’s market is important. Contact your Broker for an Opinion of Value for your property or a Lease Analysis for your workspace.