Our Take on 2018 Tax Reform

What the Senate and House are proposing for 2018 tax reform and our thoughts on how the potential changes could impact the commercial real estate market.

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Before we get into our take on potential tax reform, it’s worth noting that no proposal in either chamber of Congress has even gotten through the committee process.

No hearings have been held and no votes of any kind have been cast. Both the Senate and House have floated preliminary proposals as trial balloons to measure public response and create a framework for further debate on actual legislation. Both proposals, as we see them, contain enough controversial provisions to keep either of them from surviving a vote.

Simply put, if you are making bet on tax reform actually happening, insist on some big odds and make sure you don’t need the money for something else.

The media has been bashing both proposals and K Street lobbying firms are burning the midnight oil making their arguments for carve-outs and exceptions for the special interest groups they represent, the real estate industry included.

Republican legislators are hailing various provisions of each proposal as badly needed reform to ease the tax burden on the middle class and level the playing field for US corporations that pay a high enough tax rate to motivate them to move to other countries.

Democrats, on the other hand, universally pan both proposals as another tax cut for the rich who already don’t pay their fair share. If that sounds familiar, that’s because it is. Same ol’, same ol’.

So, here we are, getting sucked into speculating what could happen if it goes one way or the other or not at all. Sorry, folks, we just can’t help ourselves.

Let’s take a look at major provisions of each proposal and see if we can sort some things out. Unfortunately, very little detail has been provided to the public thus far, and we are fairly certain that is by design. Both plans are conceptual at this point.

What follows is look at what we have learned about some of the key areas that are in the spotlight, but all are subject to change and further interpretation. Here goes:

Corporate Income Tax Rate

Senate Plan	House Plan
Lowers the corporate tax rate from 35% to 20%, but delays the change until the 2019 tax year.	Lowers the corporate tax rate from 35% to 20% beginning in 2018.

The truth is, most corporations don’t pay the current maximum rate due to current expense deduction rules, many of which are industry specific.

Neither tax proposal gives us any guidance on what expense deductions, if any, would survive a vote. So, there is really no way to even estimate what relief either proposal would give to corporations. Count on the fact that special interest lobbies are all over this one.

Pass-Through Entity Tax Rate

Senate Plan	House Plan
A new rate that is less than the current income tax rates but not less than 30%.	A new rate not greater than 25% with a long list of caveats.

The truth here is that more than 80% of pass-through entities pay no more than 25% on non-wage income anyway.

So, it is easy to understand that the rate change won’t have much of an impact. It looks like this provision is more for show than go, and that’s disconcerting because most of you reading this blog post operate your businesses and your real estate investments using pass-through structures. However, if you are a doctor, lawyer, accountant, architect or consultant…fugetaboutit. You won’t get any benefit from either proposal.

Also, there will be new rules on how income is classified and that will hurt more than help most of us who use pass-through entities. This one doesn’t sound good to us at all. We suspect a devil in the details.

Interest Deductibility for Businesses

Senate and House Plans
Limits deductibility of interest on debt up to 30% of EBITDA. No other details offered.

Both plans appear to leave the deductibility of mortgage interest on property used for investment or business alone, but we can’t find any details on it.

Stay tuned on this one because it could, all by itself, impact property values in a huge way if current rules on mortgage interest deductibility are modified.

What we hope is that interest and property taxes (the other long-time deduction that is under siege) will be left alone. We just don’t know enough yet.

Expensing, Depreciation, 1031 Exchange Rules

Senate and House Plans
Both plans elude to the fact that all capital expenditures, other than for structures, can be expensed as operating expenses are today, along with the ability to carry losses forward to provide additional tax benefits over time in lieu of depreciation. Think Rule 179 on steroids.

We hope that real estate gets left alone in terms of depreciation and that appears to be the case for the moment.

No word on changing the economic life of structures from the current 39 years. It also appears that exchange rules will remain in play for real estate, but changes are in the works for exchanging personal property like art works and other personal property.

Again, we just don’t know how this will end up, but we do know that leaving the 1031 rules alone will avoid a massive disruption in the commercial property markets.

Stay tuned for an additional post with our take on the personal income tax components of both plans and an update on the entire issue after Senate and House committees meet to hammer out more details.