By Sean Brennan
Now that the dust of a contentious presidential election cycle is settling, tax reform may be more likely in 2017 than in past years. There are currently two plans we can look to for guidance on reform: President Donald Trump’s revised plan and the House GOP plan. Both contain significant reductions in individual and corporate tax rates, limitations on deductions and simplification of administration of the tax system. While the plans are summaries of proposed tax reform and give us a basic understanding of their intentions, neither plan answers all our questions concerning implementation for taxpayers.
Provisions of each proposal may affect the real estate industry in the long term, including the current write-off of acquired property, limitations on the deductibility of interest expense and the overall reduction of tax rates.
Tax Rate Reduction
Arguably the most important potential tax reform for both individuals and corporations is tax rate reduction. The president’s and the House GOP tax reform plans both call for significant tax rate reduction for both individuals and corporations. The two plans call for reduced corporate tax rates of 15 percent and 20 percent, respectively. Under the president’s plan, business income earned by pass-through entities would also be taxed at a 15 percent rate. Under the House GOP plan, income from pass-through entities would be taxed at a maximum rate of 25 percent. It’s not clear whether income from rental real estate would qualify as “business income” under the president’s plan. Both plans call for a repeal of the corporate alternative minimum tax (AMT).
To reduce business tax rates, the president’s plan calls for the elimination of most business deductions and credits, except the federal R&D credit. The House GOP plan also calls for reducing business deductions, including the deduction for interest expense in excess of interest income. However, there is a proposal under the House GOP plan to allow immediate write-off of investment of both tangible and intangible assets, including property.
The president’s plan proposes altering the tax treatment of carried interest. Carried interests are commonly used when forming a real estate development partnership to compensate a promoter for services rendered to the partnership with an interest in the partnership. Ultimately, the promoter can be taxed using favorable capital gains tax rates. If carried interest taxation rules are changed, promoters may be required to pay taxes on receipt of carried interests using ordinary tax rates.
The last rewrite of the Internal Revenue Code (IRC) in 1986 extended depreciable lives for commercial real estate from 19 years to 31 years. Depreciable lives now are set at 39 years for most properties acquired in 2017. As mentioned above, the House GOP plan includes immediate expensing of all acquisitions of tangible and intangible property. Therefore, commercial buildings and other real estate development would be fully written off in the year acquired or placed in service. A similar provision is included in the president’s revised plan, which proposes full expensing of plant and equipment for manufacturers. But the plans also call for the elimination of deductions for net interest expense on debt. Thus, interest expense deductions would be disallowed to the extent they exceed the taxpayer’s interest income. Taxpayers would have to weigh the benefits of the simplification of an immediate write-off of newly acquired property against the loss of tax deductions for interest on the debt used to acquire the asset. Net operating losses resulting from the immediate expensing of commercial real estate would be able to be carried forward indefinitely, with no carryback allowed.
Mortgage Interest Deduction
Currently, mortgage interest payments for acquisition debt up to $1 million and $100,000 in home equity debt are deductible. The president’s plan calls for limitations or phaseouts of itemized deductions at $100,000 for single filers and $200,000 for married filers. The House GOP plan calls for the elimination of nearly all deductions except the mortgage interest deduction and charitable contribution deduction.
Alternative Minimum Tax/Net Investment Income Tax
Under both the president’s plan and the House GOP plan, AMT and the net investment income tax (3.8 percent on net investment income) would be repealed.
Looking ahead: We’ll be watching
While it is very early in the process of rewriting the IRC, the prospects of reform continue to grow stronger with a Republican White House and Republican control of the House and Senate. Real estate companies can review potential reforms now to prepare for scenarios that could be ahead. We will continue to monitor these preliminary tax reform plans, as well as others that may arise, in the coming months as the process unfolds.
This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com