LOIS WEISS: How The Tax Reform Bill Favors Real Estate Investments

Real estate executives and investors may have lucked out so far with the proposed Tax Cuts and Jobs Act, but until the yeas have it — and it’s delivered by both houses of Congress and signed by President Donald Trump — anything can happen.

Both the House and the Senate are focused on the broad strokes of reducing the number of brackets, reducing taxes on the middle class, dropping taxes on businesses and repatriating offshore funds.

But how Congress gets there is always a bumpy journey, and how the ultimate provisions affect real estate and the individuals who work in the industry could take a while to shake out.  

“Whenever there is a tax change, it alters real estate pretty dramatically,” Eastern Consolidated Senior Managing Director Adelaide Polsinelli said.

In 1986, the industry warned the raising of capital gains tax from 20% to 28% would turn into a debacle, and it did, but it still took years to take shape and plunge the economy into a recession.  

When Congress decreed in 2012 the capital gains tax would again rise from 15% to what would add up to 25% for those in higher brackets, it caused a mad rush for sales and closings before the end of that year.

“The problem with real estate ... is that it takes so long to react,” Polsinelli said. “To respond, react and readjust takes time.”

That’s one reason Polsinelli hopes any changes will be phased in over time, to give the markets time to adjust.

But since real estate transactions are driven by taxes, Polsinelli said. “Everyone goes through these machinations to structure deals to avoid taxes.”

So far, most real estate investors are thrilled that it maintains the 1031 tax-free, like-kind exchanges for real estate, even though that tax-free swap is being dumped for all other industries.

Since many high-cost state elected officials — read New York, New Jersey and California — are howling over the House’s proposed limitation of state and local property tax deductions to $10K, as well as the loss of education credits, it is likely the 1031 will remain and stay under the radar, despite other possible changes.   

But buying a property in a foreign country to replace a sold one here is a no-no as the bill has a new section that decrees: “Real property located in the United States and real property located outside the United States are not property of a like kind.”

Duh.

Additionally, the property must not just be held for sale, but must be held for “productive use or investment," a phrase that will likely be parsed and litigated in the future.

The bill also caps the tax rate to be paid on dividends from real estate investment trusts to 25%, putting its taxation in line with dividends from other stocks, making them a more appetizing investment for individuals and institutions. REITs like SL Green, Vornado and Boston Properties will surely be pleased.

Foreign investors that have subsidiaries that invest in U.S. property will also be rewarded as the current tax on their investments will be eliminated.

Those that conduct business through LLCs, partnerships, sole proprietorships and S corporations, which includes many in the real estate industry, will likely see their tax rate drop, but there will be plenty of new rules.

Additionally, because owning real estate is not usually considered a “personal service” business, this could hurt executives in their own pocketbooks. Brokers that make a lot of money through commissions, for instance, will see their taxes go up by about 10%, warned Cushman & Wakefield Chairman of New York Investment Sales Bob Knakal.

“The lowering of the corporate tax rate and the lowering of rates on LLCs and pass-through entities, which excludes service businesses, will be very good for commercial real estate as it will make corporate profits double, " Knakal said. "With those profits, companies should go out and hire more people, and I believe they will, and this will lead to a demand for more real estate.”

While the low-income housing tax credit is retained — a plus for affordable housing developers — the tax exemption is dumped for the private activity bonds that are also used to create such housing, making it a negative, and already the subject of lobbying by affordable housing providers and cities.  

Although the House bill will no longer allow homeowners to deduct mortgage interest and the Senate bill keeps it, both bills provide that businesses would still be entitled to deduct this expense.

Koeppel Rosen LLC principal David Koeppel, who manages the Rosen family portfolio, said leases must now specifically state that any tenant improvements become the owner’s property.

“Otherwise you are not going to be able to capitalize the costs,” he said. “Most leases have that language in there, but now the legislation says you can’t capitalize if you leave it out.”

The Real Estate Roundtable took a positive view of the House bill but declined to address any specific provisions.

“The bill would reduce the tax burden on all job-creating businesses, not only C corporations,” Roundtable President and CEO Jeffrey DeBoer said. “If the final bill is similar to the one introduced today, our industry will put more people to work modernizing and improving existing properties — office buildings, shopping centers, apartments, industrial properties — to meet the changing and growing needs of American businesses and consumers.”

But The Georgetown Co. CEO Adam Flatto expressed concern over the bill. 

“The complexities and unintended consequences of these provisions are far-reaching," he said.

Lois Weiss is a Bisnow featured columnist as well as a real estate reporter for the New York Post. She has covered New York City real estate for more than two decades and is a past president of the National Association of Real Estate Editors.