For CRE, Tax Act A Cause For Celebration, But Questions Linger

When Congress, at long last, passed the embattled Tax Cuts and Jobs Act Dec. 20, commercial real estate professionals celebrated the bill and its favorable provisions for the industry. But upon reading the fine print, many are left wondering how the government will implement the legislation.

Even tax experts, who have called the changes to the tax regime the most pervasive since 1986, are unsure how certain rules will be applied and calculations made.

Bisnow caught up with Mazars partners George Moffa and John Ohannessian to hear their best predictions for how tax legislation will impact CRE.

Transaction Rate And Dollar Volume Will Increase

The TCJA has brought rate slashes and more favorable treatment of rental income and REIT dividends, leading to extra market liquidity.

“In general, taxes will be lower, and more free cash translates to more deals,” Moffa said. “Still, we find people tend to re-examine their transactions any time there is tax reform, to figure out what effect it will have on their deals.”

Some big boons to CRE include the new bonus depreciation rule, which used to be 50% of the improvement dollar value and only apply to new equipment. Now, it is 100%, and applicable to new and used equipment, as long as the equipment is new to the specific taxpayer.

Lower effective rates for REIT dividends, which will be taxed at an effective rate of 33% rather than 43%, also favor CRE and are expected to encourage investment. Investors qualifying for the 20% deduction will see their net income from rents taxed at 29.6%, down from 39.6%.

“Any time you lower the tax rates and put more money in the pockets of real estate investors, they are likely going to put that money back into real estate,” Ohannessian said. “For this reason, I see the tax act stimulating the economy, and, at least in the real estate world, a net positive.”

Uncertainty Lingers

Many sections of the legislation, which was drafted in a rushed and secretive manner, remain ambiguous, according to Moffa.

“We finished off 2017 in a hasty haze of tax reform,” Moffa said. “It was meant to simplify things, but it has done the opposite. The industry will be doing financial modeling for the next six months.”

For example, carried interest only receives capital gains treatment if the asset has been held for three years, instead of one year, and this change has executives wondering if they can restructure to circumvent the longer holding period.

“It says in the law that if you hold an interest through a corporation you are not subject to the rule,” Ohannessian said. “Practitioners are asking whether they can set up an S corporation to avoid this rule.”

Since this loophole was likely unintentional, lawmakers may issue a technical correction to close it. Interest limitations are also a gray area with the potential to complicate planning and filing.

“There is some confusion as to how interest limitations will be implemented, the interplay at the entity level to the taxpayer level, and whether you can aggregate different business activities,” Moffa said. “Section 163(j) is up in the air until the IRS releases guidelines, likely at the end of the summer.”

Tax pros are looking to the IRS to clarify and issue guidance that addresses both specific definitions and broad terminology.

“When there are so many unclear positions, we really need guidance to understand how calculations will work,” Ohannessian said. “For example, for qualified improvements, they left out the number of years that constitute useful life. We expect such urgent items to be addressed by summer, although a technical correction is unlikely since it requires 60 votes to avoid a filibuster in the Senate.”

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