Tax Reform Manifesto for the Real Estate Industry
This posting is a part of a 3-part series. The full article will be available in thecoming weeks.
By Alexander J. Narcise, CPA, with contributions from the entire Wiss Real Estate Team:
- Michael Kroll, CPA
- Steve Warholak, CPA
- Michael Bodrato, CPA
- Kyle Pennacchia, CPA
- James Jenco, CPA
- Ken Trainor, CPA
- Phil London, CPA
- Chris Gati, CPA
- Charlie Komack, CPA
My take on this whole thing:
The Internal Revenue Code has historically provided many planning opportunities for real estate investors and developers. In our practice, we have been able to save real estate clients a significant amount of tax dollars through various deferral techniques, accelerated deductions, credits and tax-free exchanges. Frankly, it has made our careers rewarding because of the value drivers we have been able to provide clients. “Know your craft” is what I continually talk to my staff about so we can deliver the highest quality service to our real estate clients and the industry as a whole. I must say I wasn’t really all that nervous when tax reform came around; how could tax reform not benefit the real estate industry? After all, real estate and construction industries have a significant impact on the US Economy. According to a NAIOP’s 2017 Economic Impacts of Commercial Real Estate:
The total contribution to gross domestic product (GDP) of building and non-building expenditures also generated new personal earnings and supported jobs across all sectors of the economy. In 2016, the $1.16 trillion in construction spending:
- Contributed $3.4 trillion to U.S. GDP;
- Generated $1.1 trillion in new personal earnings;
- Supported a total of 23.8 million jobs throughout the U.S. economy.
The Internal Revenue Code has always been favorable to real estate investors and developers to help drive the overall contribution to the economy. It’s been a crazy ride since tax reform came into play with all the conversations we have been having internally and externally. I named one of my partners the “Adam Schefter of Tax Reform” as he was always getting live updates from inside sources. It was really funny when we were in a partner meeting discussing this and periodically he would get new info in real time to his phone. If anyone doesn’t know Adam Schefter, he is ESPN’s insider for the NFL and has a knack for getting inside information. The week before the New Year was fun, “to Prepay or not to Prepay, that is the question”. Is that Shakespeare? It was great to have these important conversations with clients and assist in the navigation of the new tax policy. I am not sure I would call it reform; moreso for accountants and lawyers to interpret and advise on. Yeah for us (although accountants and lawyers do not get the benefit of the Pass-through deduction), so bad for us.
Wiss is in a great position to advise the real estate industry on all the new changes. If you or anyone ever has any questions, don’t hesitate to contact someone on the team. We take pride in our forward-thinking practices with our clients, taking a proactive approach and being sure we are responsive to their needs. We are here to help. From the beginning when the dust settled, I wanted to put something out specifically for the real estate industry OF THEWAY THINGS WERE AND THE WAY THINGS WILL BE.
Below are highlights of the new tax policy that will affect real estate the most:
- On the business interest deduction, real estate companies with average annual gross receipts of $25 million or less would be exempt from the limit. If you are over the limit then you would be limited to 30% of Earnings before Interest, taxes, depreciation and Amortization for four years (2018 through 2021) then 30% of Earnings (you deduct depreciation and amortization) before interest and taxes thereafter. Any excess can be carried forward indefinitely. This law will require us to aggregate all of your real estate gross receipts to see if you are over the $25 million. If over $25 million then the limitation may apply. However, there is one business that can opt out of the limitation and it’s the real property trade or business. There is a trade-off however, and if you opt out to avoid the 30% interest expense limitation then you must depreciate your real estate, qualified improvement property and personal property under the Alternative Depreciation System (ADS). This means you will have to depreciate these assets over a longer period of time and will not be able to utilize the new 100% bonus depreciation. This will require a lot of planning and communication to ensure the best strategy possible.
- The pass–through deduction allowable under the new tax policy will be 20% for businesses that have qualified business income under $157,500 (if single) or $315,000 (if married filing jointly). Real Estate is considered a qualified business under the new law. The deduction becomes a little more complex if you have income over the above thresholds. This calculation takes the lessor of 20% of qualified business income or the greater of, 50% of the W-2 wages or 25% of the W-2 wages plus the 2.5% of unadjusted basis after acquisition. At first, I was questioning how much of a benefit this will have for the real estate industry because initially it appeared you needed wages, so I thought we were going to have to get creative. However, late in the game they added a provision that allowed 2.5% of unadjusted basis, immediately after acquisition. This was an important add on for the real estate industry. In the end, the pass-through deduction will benefit older properties that don’t have as much shelter as newer properties. The reason is any new (whether under development or existing) properties that will be placed in service under the new tax plan will get the benefit of 100% expensing for assets that have a recovery period of 20 years or less. This includes personal property (typically 5, and 7 years) and land improvements (typically 15 years). The 100% expensing on new property will most likely create a business loss and the new pass through deduction can’t be used to create a loss. The benefit will come into play where the taxable income is high and wages are low. See 100% expensing in Part 2 here.