The Impact of Tax Reform on The Real Estate Sector

photo by Sergiu Bacioiu

Congress passed the tax reform act on December 20, 2017 and President Trump is supposed to sign it by the end of the week. A lot of ink has been spilled on the impact of tax reform on homeowners, but less on real estate as an investment class. It will take lawyers and accountants a long time to understand all of the in ands outs of the law, but it is pretty clear that commercial real estate investors will benefit significantly. Most of the provisions of the act are effective at the start of the new year.

Homeowners and the businesses that operate in the residential real estate sector will be impacted in various ways (the net effect on any given taxpayer will vary significantly based on a whole lot of factors) by the increase in the standard deduction; the limits on the deductibility of state and local taxes; the shrinking of the mortgage interest deduction; and the restrictions on the capital gains exclusion for the sale of a primary residence. There are tons of articles out there on these subjects.

The impact on real estate investors has not been covered very much at all. The changes are very technical, but very beneficial to real estate investors. There are a couple of useful resources out there for those who want an overview of these changes. The BakerBotts law firm has posted Tax Reform Act – Impact on Real Estate Industry and the Seyfarth Shaw law firm has posted Tax Reform for REITs and Real Estate Businesses.

To understand the impacts on the real estate industry in particular, it is important to understand the big picture.  The new law lowered the highest marginal tax rates for individuals from 39.6% to 37% (some individuals will also need to pay unearned income Medicare tax as well). The highest marginal tax rate applicable to long-term capital gains stays at 20% for individuals. The other big change was a reduction in the corporate tax rate to 21%. Because qualified dividends are taxed at 20%, the effective tax rate on income from a C corp that is distributed to its shareholders will be 36.8% (plus Medicare tax, if applicable).

Benefits in the new law that particularly impact the real estate sector include:

  • REITs and other pass-through entities are eligible for as much as a 20% deduction for qualified business income;
  • favored treatment of interest expense deductions compared to other businesses;
  • Real estate owners can still engage in tax-favored 1031 exchanges while owners of other assets cannot; and
  • Some types of commercial real estate benefit from more favorable depreciation provisions.

While it is clear that real estate investors came out ahead with the new tax law, it is not yet clear the extent to which that is the case.

JFK on Independence Day

JFK profile

Here is an excerpt from Some Elements of the American Character, Independence Day Oration by John Fitzgerald Kennedy, Candidate for Congress from the 11th Congressional District, July 4, 1946:

The American character has been not only religious, idealistic, and patriotic, but because of these it has been essentially individual.

The right of the individual against the State has ever been one of our most cherished political principles.

The American Constitution has set down for all men to see the essentially Christian and American principle that there are certain rights held by every man which no government and no majority, however powerful, can deny.

Conceived in Grecian thought, strengthened by Christian morality, and stamped indelibly into American political philosophy, the right of the individual against the State is the keystone of our Constitution. Each man is free.

He is free in thought.

He is free in expression.

He is free in worship.

To us, who have been reared in the American tradition, these rights have become part of our very being. They have become so much a part of our being that most of us are prone to feel that they are rights universally recognized and universally exercised. But the sad fact is that this is not true. They were dearly won for us only a few short centuries ago and they were dearly preserved for us in the days just past. And there are large sections of the world today where these rights are denied as a matter of philosophy and as a matter of government.

We cannot assume that the struggle is ended. It is never-ending.

Eternal vigilance is the price of liberty. It was the price yesterday. It is the price today, and it will ever be the price.

The characteristics of the American people have ever been a deep sense of religion, a deep sense of idealism, a deep sense of patriotism, and a deep sense of individualism.

Let us not blink the fact that the days which lie ahead of us are bitter ones.

May God grant that, at some distant date, on this day, and on this platform, the orator may be able to say that these are still the great qualities of the American character and that they have prevailed.