After many years of elected officials talking about our “broken tax code,” and fits and starts through several different congresses and presidential administrations, a comprehensive rewrite of our tax code is about to be enacted into law. The Senate followed the example of the House of Representatives and passed the Tax Cuts and Jobs Act, a massive tax reform package that is the biggest reform since passage of the Tax Reform Act of 1986. To put things in historical perspective, House of Representatives Speaker Paul Ryan, one of the leading advocates for tax reform in Congress, was in high school when the last tax code overhaul was enacted. President Donald Trump has said he would sign the legislation.
The process and votes thus far have been a purely partisan exercise, and the rhetoric on both sides has been heated and often times misleading. Time will be the true judge of whether this tax code will spur economic growth and job creation, as its supporters believe. NAIOP’s guiding principle on this long road to tax reform has been to ensure that the resulting tax paradigm treat our industry fairly, and that our members not be disadvantaged in the marketplace compared to other industries. As is often said in Washington, “if you are not at the table, you are on the menu.” We were determined to be at the table. There would not be a repeat of the unintended consequences of the 1986 Tax Reform Act, which was disastrous for the commercial real estate industry.
Real estate faced a daunting challenge. One of the most important facets of this debate was a widely-shared view that our corporate rate structure was outdated, and that our high corporate tax rates and worldwide system of taxing corporate profits put us at a disadvantage internationally. In order to lower corporate tax rates substantially, other provisions of the tax code would have to be scaled back or eliminated. This “broadening of the tax base” for the benefit of corporations could cause economic harm to those involved in real estate ventures. Long-standing provisions in the tax code which reflected the economics of modern-day real estate markets were at risk, not so much for policy reasons, but primarily because ending them would bring in revenue to offset corporate rate reductions. The negative impact would be magnified because much of the business of commercial real estate is done through so-called “pass-through” entities –partnerships and limited liability companies (“LLCs), and not corporations. Most real estate entrepreneurs would get little or no benefit from reduced taxes on corporations, but yet could be put out of business by some proposed base-broadening measures.
What were some of the changes being contemplated? Let’s start with eliminating real estate like-kind exchanges under Section 1031. Then let’s eliminate the deductibility of interest payments on debt. And of course, there was the constant threat to tax “carried interests” not as capital gains, but at much higher ordinary income rates. Important development tax credits such as the Historic Rehabilitation and Preservation Tax Credit, the New Markets Tax Credits, and tax-exempt private activity bonds (“PABs”) were also on the chopping block.
Needless to say, enactment of any of these ideas would have caused substantial disruption for the real estate industry. Fortunately, policymakers were persuaded that, at the end of the day, it made no sense to undermine what had been healthy and well-functioning real estate markets. If a pro-growth tax code that fostered capital formation and increased job-creation was the goal, then commercial real estate would need to continue to be a major contributor to our economy.
This tax reform legislation recognizes the fundamentals of commercial real estate development, where risk-taking and long-term investment of capital are central features. Among other things, the Tax Cuts and Jobs Act would:
- Preserve Section 1031 like-kind exchanges for real estate.
- Continue taxing real estate carried interests held for three years as capital gains.
- Preserve the deductibility of business interest expense for real estate trades or businesses.
- Reduce the tax rate for many pass-through businesses, including many in real estate.
- Lower the tax rate for corporations to 21 percent.
- Double the estate tax exemption.
- Retain in part the historic preservation and rehabilitation tax credit, the New Markets Tax Credit, and the tax exemption for private activity bonds (PABs).
Regarding these and other provisions important to our industry, we provide an overview and explanation on our website.
Undoubtedly, with legislation of this size and scope, there will need to be changes in the coming years to address unintended consequences. So-called “technical corrections” bills are sure to follow, and NAIOP will be there to ensure that the industry’s viewpoint is understood. This time around, however, unlike the last time comprehensive tax reform was enacted, we are hopeful that a vibrant commercial real estate industry and a stronger economy is the result.