The Tax Cut and Jobs Act that recently passed is the most sweeping tax reform since the Reagan administration. The legislation will impact everyone, some will reap more benefits than others.
On a range of points, commercial real estate will see positive benefits under the new law. Let’s review a few of the changes that have the potential to fuel commercial real estate.
Pass-through entities such as partnerships and limited liability companies are set to benefit significantly from the new law. These are companies that do not pay direct corporate tax, but instead “pass through” their gains and losses to the individual members of the company or partnership. Under the new law, investors in pass-through entities will benefit from a new 20% deduction.
Real estate investment is almost always conducted through such entities. Owners of pass-through entities may be eligible to claim a 20 percent deduction for business-related income. For example, if an LLP owns a commercial building that provides $200,000 in annual income to its investor partners, those individual investors could avoid paying taxes on $40,000 of that income if they are eligible for the full 20 percent deduction.
1031 exchanges allow you to exchange like-kind property and roll your gain forward without having to pay tax. This provision remains mostly unchanged except for one modification.
The new rules modified 1031 exchanges to include only real property. That exclusion will have a negative tax impact on real estate assets that also contain a high amount of personal property, such as restaurants that have significant value tied up in the furniture, fixtures, and equipment. Previously, those companies were able to exchange the full amount.
The tax plan lowers most individual tax rates and increases the standard deduction.
In 2017, for a married couple the brackets were:
-10% (taxable income up to $18,650)
-15% ($18,650 to $75,900)
-25% ($75,900 to $153,100)
-28% ($153,100 to $233,350)
-33% ($233,350 to $416,700)
-35% ($416,700 to $470,700)
-39.6% (taxable income over $470,700)
Under the new plan they would be:
-10% (taxable income up to $19,050)
-12% ($19,050 to $77,400)
-22% ($77,400 to $165,000)
-24% ($165,000 to $315,000)
-32% ($315,000 to $400,000)
-35% ($400,000 to $600,000)
-37% (taxable income over $600,000)
Overall many of the provisions passed will have a positive impact on tax savings for investors, allowing them to keep more of their earned income. Another factor that could impact real estate includes the “tax holiday” that allows corporations to repatriate some of the trillions of dollars that are held outside the U.S. with a significantly smaller tax penalty. This may very well drive demand in many areas if that cash is invested back into the economy as expected. Lastly, most Americans should see some tax savings from the above rate reductions, 401k increases, and hopefully higher wages and bonuses. This means more money for retail goods and services that will drive up consumer spending and boost the economy.
With any legislation this size, it will take time to determine the net effect but initial analysis appears promising for economic and job growth that will, in turn, drive demand for commercial real estate.