Predicting the future for commercial real estate is always difficult, but it’s made significantly more so this year because of the real possibility of massive federal income tax reform. Big-time reform would have been unlikely if Hillary Clinton had won the White House and divided government had continued, but with a Trump victory and Republican control of both houses on Capitol Hill, tax reform on a 1986 scale may really happen. That “1986” reference should grab the attention of anyone working in commercial real estate – older readers will remember the impact on the industry of the 1986 reform, and younger readers studied it in school or have heard the stories from their more senior colleagues.
So could it happen again? Maybe. Some of the specific changes being considered would certainly have big impacts on our industry. For example, the elimination of 1031 tax-free exchanges, removing the deductibility of interest on real estate loans, and ending the current favorable treatment for carried interest. If the industry is hit by all these changes at once, the consequences could be especially painful.
Let’s consider the context for these proposals. Republicans are concerned about labor force size due to Baby Boomer retirements, a declining workforce participation and declining worker productivity. The latter is a consequence in part of historically low levels of capital investment. They hope to address these issues with large-scale reform that would include the following:
–Corporate income tax rate cut (from 35% to 20% or lower)
–Individual income tax rate cuts and simplification (three brackets instead of seven, with a top rate of 33%; increases in standard deductions to reduce need for itemization by many taxpayers)
–Elimination of corporate and individual alternative minimum tax
–Increases in child and dependent tax credits
–Protection of interest rate deductibility for home acquisition financing, but elimination of deductibility of interest on all other types of loans, including home equity loans and commercial real estate loans
–Elimination of estate tax
–Creation of a special 25% rate for income from sole proprietorships and pass-through entities such as partnerships and LLCs, with reasonable salaries to owners being taxed at ordinary individual rates
–Reorganization of the IRS into separate units for business and individual taxation, and the addition of a “small claims court” unit
–Get rid of multi-year depreciation for business investment, so capital investments are fully expensed in the year they are made
While these proposals are grounded in economic ideas about fair allocation of the tax burden and promoting economic growth, each industry will ask “what’s in it for me?” For commercial real estate, the unfavorable proposals outlined above, or at least the ending of interest deductions, might be offset by the current year expensing of all capital investment expenditures, with the exception of land. This proposal takes some getting used to for anyone who has thought in terms of 39-year depreciation!
Watch what happens in Congress carefully this year. It may have a significant impact on your livelihood.