Be Careful What You Ask For – Part 2: The 2017 GOP Corporate Tax Proposal

An overview of the 2017 GOP corporate tax proposal – what we know will change, what we don’t know, and how it will all impact corporations.

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Last week we took a cursory look at some of the basic elements of the GOP’s tax reform proposal.

The package contains changes to marginal income tax rates, itemized deductions, personal and dependent exemptions, gift and estate taxes and a reduction in capital gains rates.

Of particular interest to us is the potential impact these proposed changes would have on the commercial real estate market. Given the bold nature of the proposal, especially if all its components became law, we think it is important for all of us in the real estate business to understand it to the fullest possible extent.

Today we look at the corporate side of the tax proposal, which is also bold, but perhaps even more controversial.

For years, we’ve been hearing about the fact that the US government taxes corporations at a rate well above that of almost every other country. Currently, that rate stands at 35%, but the GOP proposal, dubbed by its authors as A Better Way, would slash that rate to 20%. That alone will certainly come as welcome news to companies burdened by the current rate.

But, there is much more to the proposal, some of which has come under severe scrutiny from both sides of the political aisle. Here are a few of the highlights:

• Traditional depreciation schedules for capital investments would be eliminated and the full amount of new investment would be expensed in the year invested (excluding land)
• Losses generated by expensing of capital investments could be carried forward indefinitely to offset future income from investments, effectively replacing depreciation
• The corporate Alternative Minimum Tax would be eliminated
• Interest on debt would no longer be deductible (except for a personal residence)
• Write-off for Research and Development would remain, but many other deductions would disappear (as yet not clearly defined)
• Overseas cash stockpiles could be “re-patriated” at a one-time rate of 8.75% which could be amortized over 8 years
• A new border-adjustment tax will disallow the deduction for the cost of imported goods sold in the US, and the exemption from income taxes on revenues resulting from the sale of goods exported from the US

It’s the last one on this list that is getting the most attention because it is a new and completely untested idea. More on that one in a minute.
Expensing capital investment in year 1 and then carrying the resulting losses forward is also new.

It eliminates the protracted and sometimes arbitrary useful life attached to different asset classes, and it means that the cost of a capital item is recouped in today’s dollars. Count on the fact that number crunchers all over the country are burning the midnight oil on this one.

For real estate, it means the 39 year depreciation schedule is gone and at this point, we are unsure about what that will mean to commercial property as an asset class. Of course, most of us tend to fear what we don’t fully understand, so we think there may a lull in sales activity until the market figures it out.

The elimination of the evil Alternative Minimum Tax at the personal and corporate levels will be celebrated by all. End of story.

Ending the write-off of mortgage interest will take a lot of getting used to. It is one of the primary tax benefits of owning real estate on a leveraged basis. Hopefully, the loss carry-forward provision of the plan will compensate for the loss of the interest deduction, but until we develop comparative modeling tools, we won’t know.

Here again, the lack of understanding may cause acquirers to hit the pause button on new deals until things get sorted out, but anything that dampens demand is a threat to pricing.

After reading the GOP proposal in full, there are many issues that have yet to be quantified.

While R&D costs for business will still be deductible, the plan calls for the elimination of other business deductions, but offers no specifics.

That concerns us because we see this area as being one where some win and some lose, and that will cause considerable uncertainty and may result in a business slowdown as companies play a game of wait-and-see while the politicians and bureaucrats rewrite the rulebook.

The repatriation of over $2 trillion stashed overseas sounds like a good idea all around. What’s not to like about having that much new capital available? The rate for the one-time move of overseas cash is low enough to make it actually happen and the eight year amortization option won’t hurt either. Supposedly, the border adjustment tax and lower corporate tax rates will keep the problem from occurring again, as there will no longer be a penalty for earning income outside our borders.

Back to the border adjustment tax. In a word, it ‘spooks’ us, and for several reasons. While we don’t profess to be experts in international taxation law, it concerns us that an importer and seller of goods like Walmart, will pay income tax of 20%, and an exporter of goods like Boeing will no income tax on the sale of its aircraft.

Also, suppliers of commodities, oil for example, often have the option of selling their products to domestic or foreign customers. This may result in a price hike to domestic customers who buy from an oil producer who could otherwise sell its product to foreign customers without paying income tax on the revenue.

A recent article in the Wall Street Journal cited a study that predicted a rise in gasoline prices of roughly $400 per person per year if the border adjustment tax were enacted. But without this component to offset lower corporate rates, the plan may become the primary culprit for rising budget deficits, which already drifting higher again.

Picking winner and losers is dangerous business and the more we hear about this controversial taxation methodology, the more we understand why it is getting so much pushback.

At this point, it is completely unknown as to which elements of The Better Way will become the law of the land. What is known is that the ‘fur is gonna fly’ once tax reform enters the center ring of the circus.

The left will claim the whole plan is a scam in favor of the one-percenters, while the right will hail it as high-octane fuel needed to drive economic growth above 3% again.

We will keep doing our research and report back to you as we hear on how the commercial real estate market will be affected. Right now all we really know is that we don’t know enough. Stay tuned.