At the end of 2017, Congress passed and President Donald Trump signed a sweeping tax reform bill. For the most part, commercial real estate professionals fared well in the reform process. Many of the provisions they rely on were preserved, while tax rates were reduced and the system was mostly simplified.
Tax is profoundly important to our members and their businesses, noted NAIOP President and CEO Thomas J. Bisacquino. NAIOP recently provided an exclusive webinar to help members understand the changes in the new law as part of NAIOP’s members-only Advantage Series. Crystal Christenson of the accounting firm Wipfli, LLP, who chairs the firm’s construction and real estate tax practice, presented her analysis of this complex topic.
Among the crucial provisions of the Tax Cuts and Jobs Act, Christenson cited:
- The 20 percent flow-through deduction.
- Changes to depreciation rules, including asset lives.
- The 30 percent limitation on business interest deduction.
- Section 1031.
- Government and civic group grants.
- Excess business loss limit and use of NOLs.
- Carried interests.
- Rehabilitation tax credit.
- Qualified Opportunity Zones.
Of these, two key issues stand out for the CRE industry.
The first is the 20 percent flow-through deduction, which Christenson calls “perhaps the most talked-about and least-understood provision in the new tax law.” Under the former law, C corporation income was taxed at a 35 percent top rate, and flow-through income was taxed at a top rate of 39.6 percent. Under the new law, C corporation income is taxed at a flat rate of 21 percent, flow-through income is taxed at a top rate of 37 percent, with a 20 percent deduction for qualified income that reduces that top rate to 29.6 percent.
Christenson also warned NAIOP members that, despite the difference in rates, it doesn’t necessarily make sense for CRE professionals to reclassify their business as a C corporation. “There are a lot of other tax issues that you have to consider,” she warned, as well as “a lot of other, non-tax issues that you have to take into account.” She suggested that most clients are better off continuing to pay taxes as flow-through entities, as C corporations are still subject to the second layer of tax when profits are distributed to shareholders.
For flow-throughs, there are limitations on the 20 percent deduction. “If your total taxable income exceeds certain thresholds, two other limitations will come in,” Christenson explained. “One is the W-2 limitation, and the other is called the specified service limitation.”
That means that the deduction is capped at 50 percent of W-2 wages paid, or 25 percent of such wages plus 2.5 percent of qualified property, and is not available to professional services businesses (such as law firms). However, married taxpayers who earn less than $315,000 are exempt from this latter restriction and can take the 20 percent deduction regardless of the type of income they earn. Christenson pointed out that there are still interpretations about these policies that will be made by accountants and by the IRS.
The second area Christenson discussed was the revised tax depreciation rules. These, she said, are mostly favorable to taxpayers. The changes include an expansion of bonus depreciation, or the percentage of the cost of qualified expenditures that a business can deduct in the first year. It increased from 50 percent to 100 percent, meaning businesses can fully deduct the cost of most capital expenditures in the same year in which they are purchased. In years past they could deduct 50 percent but had to spread the remaining deduction over several years, according to the asset’s lifespan. This incentive is also expanded to include pre-owned property
However, Christenson highlighted for NAIOP members an issue with the new law that is sure to affect many in the CRE industry. Lawmakers had intended to consolidate various categories of “improvement property” into one asset class, called Qualified Improvement Property. Rather than having a 39-year lifespan, as was the case previously, it was supposed to be changed to 15 years, as a way of more accurately reflecting the usable life of such improvements (such as a build-out for a tenant). But due to a drafting error, the law as passed actually applies a 39-year lifespan to QIP. It’s likely that Congress will need to pass a technical corrections bill to correct the mistake.
As with any major law, it will take time for changes to become obvious. NAIOP will be helping our members be aware of those changes, as they file this year and in the years ahead.
The Advantage Series is an exclusive member benefit, delivering expert insights into the latest research to help you make informed business decisions. This webinar was presented on February 27, 2018. NAIOP members can view the full archived webinar and presentation online. Register for the upcoming Advantage Series webinar, “Evolving Real Estate from Commodity to Experience” on March 20, 2-2:45 p.m. ET.