Tax Reform Provisions Hit Home in the Real Estate IndustryBy Abe Schlisselfeld | January 15, 2018
The sweeping tax reform bill signed into law last month ushered in plenty of changes for individuals and businesses this year. Some of the new provisions will be particularly important for the real estate industry. As you might expect, some of the key provisions are quite complex, and the mechanics of how to apply them are somewhat confusing.
We are all anticipating additional guidance from the IRS on how to interpret some of the provisions. Marks Paneth will continue to monitor and analyze these developments to gain further clarity on the new regulations.
At this point in time, real estate professionals should be aware of the following significant updates to tax law.
Pass-through Income Deduction
The Tax Cuts and Jobs Act (H.R. 1) creates a new deduction for qualifying pass-through income. Generally, any businesses (except specified service businesses) are eligible for the deduction. The deduction is limited by the LESSER of A) 20% of qualified business income or B) the GREATER of 50% of W2 wages paid by the business OR the sum of 25% of W2 wages plus 2.5% of the unadjusted basis, immediately after acquisition (NOT fair market value), of all tangible depreciable property of the business.
An added victory for the real estate industry is the allowance for 2.5% of the original purchase price of a building and improvements (i.e. unadjusted cost basis) to be factored into the calculation of the 20% pass-through income deduction. This was a last-minute addition to the bill that signals significant savings for CRE investors, particularly those who recently purchased properties at higher prices. This change has the potential to reduce their real estate investments to an effective 29.6% tax rate – 10 points lower than it was for high-net-worth investors in 2017.
Exemption from Interest Expense Limitation
The real estate industry was also given an exemption from the interest expense limitation. All other industries are limited to deduct 30% of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). However, real estate businesses have the ability to make an election so that there are no limits on the amount of interest they can deduct. The trade-off for making the election is giving up some accelerated depreciation, so the value of this benefit should be analyzed on a case-by-case basis.
The real estate industry is known for being highly leveraged, and this was a big win for the industry.
Excess Business Losses
Excess business losses – defined as the excess of aggregate deductions attributable to the taxpayer’s active trades or businesses above the aggregate gross income or gain from such businesses – greater than $250,000 ($500,000 for joint returns) are disallowed. Instead, they become a net operating loss in the subsequent year, subject to the rules applicable to net operating losses. This is a significant change for real estate professionals and should be evaluated for any planning opportunities.
Much to the relief of many real estate investors, the new tax law preserved 1031 exchanges for real property. However, the tax-deferred exchange can no longer be used for investments in other asset classes (e.g. artwork and others).
Tangible personal property placed in service from September 27, 2017 and before January 1, 2023 can be expensed immediately under the new tax law –provided there was no effective binding contract in place on September 27, 2017. This change essentially doubles the bonus depreciation expense. In addition, the regulation no longer requires the property to be new – it only has to be the original use of the property by the taxpayer.
The limit for Section 179 immediate expensing has also doubled from $500,000 to $1 million, effective January 1, 2018.
Last fall, as we were anticipating the unveiling of the final tax reform bill, our Real Estate Group surveyed the NYC commercial real estate industry for our annual end-of-year Gotham CRE Monitor survey. The results indicated that the majority (70%) of commercial real estate investors in New York City had not planned any changes to their investment strategy based on the upcoming tax reform. This “wait-and-see approach” will likely continue, considering the amount of ambiguity in the new tax law and additional changes on the horizon.
Marks Paneth will unveil the entire survey findings later this month, including outlooks on lending, property values, office and retail sectors, and more.
The Marks Paneth Real Estate Group will present a webinar on the new tax bill and its impact on the real estate industry on January 31, 2018. The interactive session will provide in-depth insights into these tax reform measures and other provisions affecting your real estate investments and businesses. Click here to register.
About Abe Schlisselfeld
Abe Schlisselfeld, CPA, EA, is the Managing Partner of Marks Paneth LLP. In this capacity, he oversees the firm's operations, manages business development efforts and consults on key clients. He is chairman of the firm’s Executive Committee and plays a major role in developing strategy, setting policy and overseeing acquisitions. Prior to becoming Managing Partner in 2021, Mr. Schlisselfeld was the Partner-in-Charge of the firm’s Real Estate Group. In that role, he advised commercial and... READ MORE +