Tag Archives: distribution

The Impact of Tax Reform on The Real Estate Sector

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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.

Wednesday’s Academic Roundup

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Borrowing from Yourself

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MainStreet.com quoted me in Dipping Into Your 401(k) to Finance the Purchase of a Home is a Tricky Decision. It reads, in part,

Dipping into the funds she had amassed in her 401(k) account to make up the remaining difference for her down payment was not a decision that Alyson O’Mahoney embarked on lightly.

After contemplating the benefits and disadvantages of borrowing $40,000 from her retirement account to use for a down payment on her mortgage, the marketing executive for Robin Leedy & Associates in Mount Kisco, N.Y. was certain that she making the right choice.

O’Mahoney was undaunted by the prospect of having another bill each month, even though she opted out of discussing this critical decision with her financial advisor — as she knew he would discourage her.

“It all fit into my debt and income ratio and the bank was fine with it,” she said. “I pay it back automatically with each paycheck and the 5% interest goes to me. It was the easiest process.”

Many financial advisors steer their clients away from borrowing from their retirement, because employers will typically demand that you repay the loan within a short period if you leave your job or get fired. If you can’t pay it back from your savings, then the loan will be treated as a distribution that is subject to federal and state income tax, as well as an early withdrawal penalty of 10% if you’re under the age of 59.5, said Shomari Hearn, a certified financial planner and vice president at Palisades Hudson Financial Group in the Fort Lauderdale, Fla. office.

“If you’re contemplating leaving your company within the next few years or are concerned about job security, I would advise against taking out a loan from your 401(k),” he said.

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If you accept another job offer, refinancing your mortgage may be difficult when you are facing a time crunch, said David Reiss, a law professor at Brooklyn Law School.

“If you leave your job, the loan will come due, and you will have to figure out how to repay it – potentially just at the time it would be hardest to do so,” he said. “Given that it might be hard to refinance the property on such short notice, you might find yourself stuck between a rock and a hard place.”