Home Column Edward Jordan: The impact of recent tax reform on investment real estate

Edward Jordan: The impact of recent tax reform on investment real estate

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real estate tax reformThe recently passed tax reform package represents the most sweeping tax reform the country has seen since the Tax Reform Act of 1986 and will shift the dynamics of the real estate market in 2018 and beyond. While changes to mortgage interest and local and state deductions may adversely impact many homeowners, the new provisions are generally seen as positives for real estate investors and developers. In fact, many of the provisions passed will help investors by putting more money back into their pockets

TAXATION AND DEPRECIATION

Perhaps most importantly, under the new plan, the tax bill preserves the 1031 tax-deferred exchange rules that allow investors to defer capital gains on the sale of a property by reinvesting proceeds into another qualifying “like-kind” property. However, deferring gains on personal property has been repealed starting in 2018.

Another big win for real estate investors will be the treatment of income to LLCs and other pass-through entities common to real estate ownership. Owners of pass-through entities will benefit from a new 20 percent deduction of business-related income. While some taxpayers in higher income brackets will face thresholds, this is a favorable improvement compared to being taxed at the business owner’s individual tax rate. That said, with the corporate tax rate cut from 35 percent to 21 percent, it remains to be seen whether changes to tax treatment could influence how real estate ownership entities are structured going forward.

When it comes to cost recovery, businesses will be able to immediately expense the purchase of an asset. Further, the depreciation timeline stays “as is” for investors who do not elect to take the mortgage interest deduction. For those taxpayers who do, the time that property owners can depreciate a residential property has been increased from 27.5 years to 30 years, and for commercial properties increased from 39 years to 40 years.

MORTGAGE INTEREST DEDUCTIONS

While current and aspiring homeowners may be disappointed by the mortgage interest deduction cap dropping to $750,000 from $1 million, and the elimination of deductions for interest paid on home equity loans beginning in 2018, these changes may be good news for real estate investors.

In pricey urban markets such as Boston and Manhattan, as well as states with notably high property taxes such as New York and Connecticut, the new laws surrounding deductions stand to impact the number of residential properties purchased each year. If buyers shy away from homeownership, demand for multifamily rental units stands to increase, allowing investors to not only maintain high occupancy rates but ultimately raise asking rents. In these high-tax markets, the market for value-add multifamily assets will remain strong, particularly for properties in close proximity to mass transit and offering easy access to major highway and interstate systems.

PROPOSALS THAT DID NOT MATERIALIZE

While changes were initially proposed to the federal historic rehabilitation tax credit, the new tax plan actually preserves the 20 percent tax credit for those looking to rehab certified historic structures. Of note, however, the credit must be claimed within five years. Related, the 10 percent credit for rehabilitation of structures built prior to 1936 has been repealed.

Similarly, proposed changes to the low-income housing tax credit, which stood to reduce the number of affordable apartment units produced each year, ultimately leading to demand outpacing supply, were not passed. Thus, the low-income housing tax credit remains unchanged, which is good news for developers.

These new tax laws, coupled with a potential increase to interest rates on the horizon, mean multifamily and commercial real estate investors will benefit from keeping a close eye on market dynamics moving forward.

Edward Jordan is the founder and managing director of Northeast Private Client Group, an investment real estate firm with offices in White Plains and Shelton. He can be reached at ejordan@northeastpcg.com.

 
 
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