Tax Changes for Real Estate?

tax-uncertainty

Donald Trump and the Republican majorities are coming into office with plans to change the U.S. tax code. It’s not clear, however, how real estate might fare under some of the changes being discussed.

.                      tax-uncertainty

Earlier Blueprint Now Ready for Launch

A sweeping platform for overhauling most of U.S. tax laws was drawn up in June by House Republicans, and the plan appears to be gaining traction, according to real estate industry lobbyists involved in the discussions.  The blueprint had not been expected to be the subject of such scrutiny; most lobbyists expected to be involved in fighting an effort by Hillary Clinton to use tax code changes to increase collections from big commercial property owners.  Now that the election results have changed the country’s power dynamic, Washington lawyers are expressing concern that the blueprint may adversely affect real estate.

14 national real estate organizations, including The Real Estate Roundtable, recently came together to send a joint letter to Congress on key principles that should guide lawmakers’ efforts. The letter highlighted real estate’s vast economic contribution to the national economy and noted the employment provided by real estate and its central role in broad-based wealth creation and savings for investors large and small; it also communicated the great care must be taken when changing tax rules for long-lived real estate assets, or serious unintended consequences could result. The signatories represented all major property types — shopping centers, apartments, office buildings, etc. — as well as key industry employers and financiers.

The letter came on the eve of the Ways and Means Committee Republicans’ two-day policy retreat in which tax reform was the dominant subject.  House Republicans are the furthest along in developing a comprehensive tax reform bill, and the Ways and Means Committee will be “ground zero” for the tax reform debate.

Property and Expense Deductions May be at Risk

Among other things, the GOP blueprint calls for the elimination of the deduction for state and local property tax.  This might lead to a further development – namely, the weakening of the mortgage interest deduction, long considered a sacred cow of U.S. tax policy.

That development would not be universally reviled; indeed, it has been argued against by many internationally-based publications, such as The Economist, as being a tax benefit that generally favors the well-off, as shown in the below chart. Yet whatever one thinks of the policy arguments for or against such a move, it would undeniably mark a major change in U.S. tax policy.

.                           NEW_GRAPH

The proposal would also nearly double the standard deduction that taxpayers could receive, thus effectively eliminating most itemized deductions. The blueprint – dubbed “A Better Way” – makes clear that “[b]ecause of the other provisions included in the new tax system, far fewer taxpayers will choose to itemize deductions.”

The House proposal would also eliminate for businesses the current deduction for debt interest payments; a significant change, since the tax-deductible nature of leverage has long played a major role in most acquisitions of office buildings, stores, hotels and other commercial property.  In addition, the House plan would eliminate depreciation for real estate companies as well as other businesses; it would instead treat the entire cost of buying a property (excluding land) as a business expense that could be used to reduce income, with losses able to be carried forward as net operating losses.

Bold, For Sure

The House tax reform blueprint would thus take a bold approach, dramatically reducing marginal tax rates for all taxpayers and reducing taxes on investment income, but shifting toward a “cash flow” system in which depreciation rules would be replaced with the immediate expense of structures.  The House plan would also eliminate the deductibility of business interest, scale back or repeal like-kind exchanges, and implement a “border adjustability” concept for cross-border trade.

As a result, real estate industry leaders worry that fewer people will be incentivized to buy homes — or that if not handled right, the potential changes in tax law could warp the economics behind real estate, creating upheaval in the industry.

Industry officials have said that they are open to discussing ideas – as long as they’re motivated by creating jobs and not penalizing landlords.  “We’re advocates for job creation and economic stimulation,” said William Rudin, a major New York landlord and chairman of the Real Estate Roundtable.  “We don’t want to provide tax shelters.”

Beyond the House, the outlook for tax reform is less clear.  Senate Leaders and the Administration are not yet definitively on board with the House’s comprehensive approach.

A version of this article was earlier published at Think Realty.