The Potential Tax Reform Proposal Implications on Real Estate Sector
Since the majority of real estate investors do so using pass-through vehicles (such as partnerships and limited liability companies) and report income from these entities on their personal tax returns, the proposed lower tax rates for individuals can dramatically affect personal and business tax planning, returns on investments and the structuring of future transactions.
Another uncertainly involves the potential decrease of corporate tax rates and, for the first time, the possibility of corporate rates being applied to pass-through business income. Currently, the owners of such businesses reflect the pass-through income on their personal tax returns at the applicable individual rates. There has been discussion of a new tax system where the owners may elect that the pass-through organization itself would be subject to a flat tax rate of 15% at the entity level. Since real estate properties are organized mainly as pass-through entities, these proposals, if enacted, would have significant consequences on asset management and tax planning strategy.
While tax cuts generally boost economic growth, there are concerns that benefits will be offset by reducing or eliminating some tax deductions such as interest on debt paid to acquire real estate or the mortgage interest deduction for individual taxpayers. Debt financing has been a key element for the real estate sector and today the tax code recognizes interest on business loans as a fully deductible item for tax purposes; with the new legislation on the horizon, all involved in real estate should closely monitor the upcoming changes in this area as well as other possible offsets.
Other crucial tax reform considerations with potentially dramatic effects on real estate companies relate to changing depreciation lives. Some plans call for immediate expensing of capitalizable assets upon acquisition, while eliminating interest deductibility. This would make it possible to deduct the full cost of all tangible property in the year it is placed in service, which includes all real property except land. If enacted, the new rules would represent a gigantic shift in the taxation of real estate investments.
Some discussions regarding essential real estate issues express concerns about the future of Section 1031 like-kind exchanges. These provisions have been an integral and valuable part of the real estate sector, whereby the taxation of real estate gains can be deferred to the extent the proceeds are used to acquire a similar, replacement property. If Section 1031 is repealed, the real estate industry will be adversely affected.
Owners, investors and professionals in the real estate sector need to pay close attention to all tax legislation developments and look for any opportunities that may present themselves.We at Withum have a team of professionals monitoring legislative developments and will keep you advised of coming changes. Contact your Withum advisor as developments occur with any questions.
For more information or to contact one of our Real Estate Services team member, please fill out the form below.
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Rebecca Machinga, CPA, CGMA, Practice Leader of the Real Estate Services Group 609-520-1188 [email protected]
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
