As 2018 gets underway, commercial real estate professionals are looking ahead to the next project or the next deal. But before we close the books on 2017, it’s worth a quick look back at the year’s major political story: tax reform.
On Dec. 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act. The law retains, in whole or in part, many provisions that are important to commercial real estate. Like-Kind Exchanges remain in place for real estate deals. The tax code will continue to tax real estate carried interest at capital gains rates for assets held longer than three years. CRE practitioners can continue to deduct their interest expenses.
After Trump scored his surprise election victory, all of these provisions were, experts warned, at risk.
“Now that one political party controls the White House and both houses of Congress, tax reform is imminent. There is a real potential for Congress to overturn or significantly revise Section 1031,” reported Realtor magazine in November 2016.
By January 2017, an article in The Washington Post warned that tax reform “may eliminate or seriously restrict the use of tax-deferred exchanges — property swaps — under Section 1031 of the code.” Columnist Kenneth Harney added that, “If you own investment real estate and have contemplated a Section 1031 exchange, be aware: There’s a significant possibility that tax revisions could knock your plans off track. Keep a close eye on what’s happening, because it could happen fast.”
Then, in June, the Wall Street Journal issued a similar message about 1031 exchanges. “A much-loved tax advantage in the commercial real-estate industry is on the chopping block even as chances dim for the passage of a broad federal tax overhaul this year,” Peter Grant and Richard Rubin wrote. “Some in Congress have in their sights what’s known as the 1031 exchange provision, which enables sellers of real estate and other assets to defer capital-gains taxes by reinvesting the proceeds in ‘like-kind’ properties.”
Likewise, many expected the tax treatment of carried interest would be changed. “The Trump plan proposes to tax carried interest (often the profits interest received by the general partner of a private equity fund, but applicable in other contexts as well) at ordinary income tax rates,” reported law firm Baker Donaldson last January.
“The president remains committed to ending the carried interest deduction,” Gary Cohn, director of the National Economic Council, said on CNBC in September. In October, that still seemed to be the case. “With carried interest, as the president has made that an issue in the campaign … there are going to be reforms there that recognize what the president was talking about,” Rep. Tom Reed (R-N.Y.), told The Hill.
Finally, experts explained the deductibility of income interest could also be changed. As the Tax Policy Center wrote in September 2016, under the House reform plan then proposed, “All businesses would benefit from expensing of investment, which would be partially offset by the disallowance of interest deductibility, repeal of some tax expenditures, and, for corporations, the border adjustments and transition tax on unrepatriated foreign income.”
Indeed, interest deductibility was eliminated in the final bill for most businesses, but not for real estate.
“Subject to certain exceptions discussed below, beginning in 2018, the Act generally limits the annual deduction for business interest expense to an amount equal to 30 percent of the ‘adjusted taxable income’ (as defined in the following paragraph), plus the business interest income, plus the floor plan financing interest (if any), of the taxpayer for the taxable year,” as the law firm Baker Botts pointed out in December. “At the taxpayer’s election, the limitation does not apply to interest incurred by the taxpayer in any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.”
Tax reform could have targeted commercial real estate, treating it as a cash cow. Instead, as a Wall Street Journal story republished by Fox Business reported. “For commercial property owners, the final bill presents a bigger victory than many expected.” In the end, lawmakers recognized the crucial role the CRE industry plays in growing the economy and decided to protect its unique provisions. As we begin 2018, that’s something to celebrate.