House Speaker Paul Ryan (R-WI) and Ways and Means Committee Chairman Kevin Brady (R-TX) unveiled their long-awaited Blueprint for Tax Reform – the last piece in Speaker Ryan’s efforts to provide a policy agenda for the GOP’s House majority as they go into the 2016 elections – on June 24, just as the House of Representatives left for their July Fourth recess. The release of the GOP tax plan was overshadowed by the dramatic results of the vote in Britain to leave the European Union (the so-called “Brexit” vote), limiting news coverage of the blueprint’s release. Nevertheless, the House Republican majority’s comprehensive tax reform plan, if implemented, would fundamentally alter the commercial real estate industry. The changes would be the most far-reaching for the industry since the Tax Reform Act of 1986.
Overall, the plan would reduce individual, corporate and pass-through (partnerships and LLCs) business tax rates, provide for full expensing of business costs, eliminate almost all itemized deductions, and eliminate the deductibility of business interest expense, among other things. Specifically, the blueprint proposals would:
- Reduce the corporate income rate from 35 percent to 20 percent;
- Tax partnerships and LLCs at 25 percent;
- Eliminate the corporate alternative income tax;
- Allow immediate deductibility (full expensing) of capital expenses, including real property (excluding land); and
- End the deductibility of business debt interest payments.
It should be noted that upon release of the plan, both Speaker Ryan and Chairman Brady cautioned that this was the beginning of the discussion on tax reform. In fact, specific legislative language has not been drafted, nor has the Congressional Budget Office provided information on the likely costs or long-term budget impacts of the proposed changes. But while the blueprint is primarily a messaging document on tax policy for the GOP House members, it will serve as the guidepost for their negotiations with the next presidential administration. For that reason, we will be working closely with members of the House and Senate on those portions of the blueprint that could have unintended negative effects on our industry. Of particular concern are:
- Deductibility of Interest Payments for Business Debt: Business loans and debt are fundamental features of modern commercial real estate markets. Debt is used by those in commercial real estate not only to acquire property, but also to finance day-to-day operations and make capital expenditures. In fact, the development of most commercial real estate is dependent on a combination of equity investment coupled with debt. The sophisticated lending institutions and structures that exist in modern commercial real estate markets (banks, insurance companies, commercial mortgage-backed securities, etc.) provide for a high level of liquidity for our markets. In addition, smaller private partnerships and family-owned businesses in general have less access to equity than larger corporations. They rely on their ability to borrow to operate and expand their businesses. Finally, changing the taxation of business interest would of necessity alter the underlying economics of many commercial real estate transactions. If the new tax regime is applied to existing investments, real estate values would decline, costing current owners. If applied only to future borrowing, then this would discourage new development, costing jobs.
- Full Expensing: The current cost recovery system (depreciation) is replaced with immediate full expensing of tangible property and real property (excluding land). This is primarily an effort to incentivize new investment in manufacturing equipment and other such capital expenditures, which have shorter economic life spans when compared to real property assets. It is also an effort to keep faith with the GOP’s stated goal of simplification of the tax code. However, full expensing in the commercial real estate world could lead to unforeseen, and ultimately unhealthy, effects. Allowing immediate and full deductibility of expenses for commercial property could very well lead to tax-driven investment and development, rather than providing commercial space based on real market needs. In prior tax proposals advanced by Republicans (namely, former House Ways and Means Chairman Dave Camp), the opposite direction was taken – depreciation schedules for real estate investments were lengthened in order to raise revenue. While the direction of the current GOP blueprint on expensing and depreciation is much preferable to these earlier proposals, the long-term impact on the industry must be rigorously reviewed.
Of course, the nature of comprehensive tax reform will ultimately depend on the outcome of the presidential and congressional elections this November. However, it is clear that the desire to move forward on a massive overhaul of our tax system has reached a critical mass in both political parties. Whether it is addressing income inequality, as many Democrats hope to do, or simplifying the tax code and lowering tax rates, as many Republicans advocate, tax reform will be the subject of vigorous legislative debate early in 2017.